Realtor giving couple keys to new home

Your 401(k) may offer enough funds to help you afford the down payment you need to become a homeowner. (Getty Images)

It's no secret that home prices are growing. The average sale price for a new home in the U.S. was $379,500 in June, according to the U.S. Census Bureau, compared to $271,800 in the same month in 2012.

The large price tag on a home makes it difficult and, sometimes, seemingly impossible to buy real estate. The down payment, whether its 3 percent, 20 percent or anywhere in between, is a major obstacle for many buyers, and a common reason people don’t buy real estate. But this is because a lot of potential buyers don’t realize the extent of the options available to them.

One of these options is the ability to use your retirement plan – 401(k) or IRA – to help toward the down payment on a home without penalties. The IRS has guidelines for taking out a loan from your retirement plan, including a limit of 50 percent of your account balance, or $50,000, whichever is less – which could be just enough to afford a down payment, depending on the price of the home and your mortgage program. Always consult with an accountant or financial planner to ensure you are doing it correctly.

Retirement plans are all different, and each one is going to have its own specific set of rules and guidelines for taking out a loan. It’s not as difficult as it may seem and you will find it’s pretty general across the board.

[Read: How Technology Plays a Part in Getting a Mortgage Today.]

When does it make sense to take a loan from your retirement savings?

The most common reasons someone would use a loan from their 401(k) or IRA is to help with the down payment or to avoid paying mortgage insurance altogether.

In the first case, the buyer doesn’t have the 3 percent to 5 percent down payment required by conventional and Federal Housing Administration loan programs. Taking a home loan from your retirement plan can make it possible for you to have the down payment money you need to buy a home.

In other scenarios, the buyer doesn’t want to pay the mortgage insurance, which is typically required when your down payment is less than 20 percent. Taking a loan from your retirement plan in this scenario can help you save hundreds of dollars per month on mortgage insurance.

When does it make sense to use a loan from a 401(k) in order to reduce the cost of homeownership?

There is a considerable difference between putting 5 percent down on a home, versus 20 percent down after borrowing from your retirement plan.

Consider a purchase of a $300,000 house with a 4 percent interest rate.

A 5 percent down payment is $15,000, meaning your loan will be $285,000, plus mortgage insurance. Mortgage insurance is typically between 0.5 percent and 1 percent of the entire loan amount on an annual basis. In this example, it’s likely around $120 to $238 extra per month. The total cost for mortgage insurance becomes $11,160 over 93 months, or seven years and nine months.

Your monthly payments to the bank will total $1,480 until the mortgage insurance drops off the loan, which brings it down to $1,360 monthly. Over the course of 30 years, you'll be paying the total of more than $500,000, assuming a 0.5 percent mortgage insurance amount.

[Read: With Rising Interest Rates, Is Now Still a Good Time to Buy a Home?]

If you have been able to save $90,000 in your 401(k), you're able to loan yourself up to 50 percent from your retirement savings (or $50,000 if you have more than $100,000 in your retirement). Added to other savings for a 20 percent down payment, your home loan is down to $240,000 and you will not be paying mortgage insurance. At a 4 percent interest rate your monthly payments to the bank drop to $1,145 monthly.

The total loan payment in this example is a little more than $412,000 over the course of 30 years with no mortgage insurance.

The caveat is that you still have to repay the $45,000 loan you took from yourself.

This means that you will owe yourself about $828.74 per month with a 4 percent interest rate over five years. Combined with your mortgage, your monthly payment becomes about $1,974. The benefit is that you are paying the bank $1,145 and yourself $828.74, instead of paying the bank the monthly total of $1,480.

So while you may be saving $335 per month you are also raising the total monthly payment from $1,480 to $1,974 over the five-year repayment plan. While this may seem like a considerable difference, remember you are paying yourself instead of the bank.

As you pay off loans, you build equity in your house over time. The historical average of real estate appreciation is 4.3 percent. This means that buying a $300,000 home with a 4 percent average annual appreciation will be worth nearly $1 million after 30 years.

[Read: 6 Ways to Boost Your Chances of Getting a Mortgage.]

When should you not borrow from your 401(k)?

Borrowing from your 401(k) should be a last resort. If it’s the only way you can afford to buy a house, it may make sense since real estate is also an effective form of saving for retirement.

Loan defaults are the No. 1 reason it may not make sense to borrow from your 401(k). If you quit your job or want to change careers you must pay the 401(k) loan back in full within 60 days of termination of employment. If you can’t pay the loan back in full within 60 days and you’re under the age of 59 and six months, you will be taxed on the amount withdrawn as well as an early withdrawal penalty.

When it comes to borrowing from your retirement plan, you are taking more than a loan from yourself – you’re also taking a risk. In many cases, the risk of being unable to pay back the loan will outweigh the benefits, so make sure you consult a professional before taking a loan from your retirement savings.

Tags: real estate, housing, mortgages, retirement, 401(k)s, IRAs


Ryan Fitzgerald is the Founder of Raleigh Realty, a real estate firm in Raleigh, North Carolina as well as uphomes located in Charlotte, North Carolina. Ryan was named a 30 under 30 Realtor in the country in 2018 by Realtor Magazine and his work is featured on Realtor.com, Realtor.org, Inman and more. When Ryan isn't helping people find homes you can find him at local coffee shops, spending time with family and friends or working on his next projects.

Recommended Articles

Should You Move to Florida?

Devon Thorsby | May 21, 2020

Whether you're aiming for South Beach or the Panhandle, there are a few things you should know before making Florida your new home.

6 Things a Virtual Tour Doesn't Show You

Wendy Arriz | May 20, 2020

Before you buy a home based on a virtual tour, think about the details you still don't know.

How to Buy a House

Devon Thorsby | May 19, 2020

Follow these steps to get you through the process of buying a home.

How Much Will Your Home Remodel Cost?

Devon Thorsby | May 14, 2020

Before you tackle too many projects, figure out what home improvements your budget can accommodate.

What It's Like to Buy a House Right Now

Frank Nieto | May 14, 2020

Social distancing and quarantines changed, but didn't cancel, the homebuying and selling process for one homeowner.

A Checklist for Moving to Your New Home

Devon Thorsby | May 12, 2020

Make moving day less hectic by packing, planning and organizing six weeks before you relocate.

Home Office Setup Ideas

Steven Gottlieb | May 12, 2020

If you find yourself working from home regularly, there are a few things that you can do to make your home more WFH-friendly.

U.S. News Best Places Rankings

May 11, 2020

U.S. News analyzed the 150 most populous metro areas to rank places to live by category.

How to Save Energy and Cut Utility Bills

Devon Thorsby | May 7, 2020

These changes will make your home energy-efficient and cut your utility spending.

Options If Your Tenant Doesn't Pay Rent

Devon Thorsby | May 5, 2020

Communication with your tenant can help you determine the best course of action if you're not receiving rent on time.

House Painting Rules You Shouldn't Break

Don Vandervort | May 1, 2020

Whether you DIY or hire a pro, make sure each step of the process is done right.

How Past Pandemics Impacted Housing

Dima Williams | April 30, 2020

Past outbreaks such as the swine flu and SARS hold lessons for how the COVID-19 pandemic will affect homebuying and selling.

Why Move to Lower Your Property Taxes?

Steven Gottlieb | April 29, 2020

A rising property tax bill may have you thinking about a move – but consider these three things first.

Should You Sell Your Home in 2020?

Devon Thorsby | April 28, 2020

You may be wondering if now is a good time to sell your house, and the answer is: maybe.

8 New House Hunting Priorities

Lisa Larson | April 28, 2020

Homebuyers who enter the market after the risk of COVID-19 has diminished will have a whole new set of priorities for their home search.

What to Know About a Pending Home Sale

Devon Thorsby | April 23, 2020

Here's what buyers, sellers and interested parties should do while a real estate deal is pending.

How to Make a Contingent Offer on a Home

Devon Thorsby | April 21, 2020

Whether you're concerned about the COVID-19 pandemic or what an inspection will reveal, here's how a contingency clause can protect you in a real estate deal.

How to Move During the Pandemic

Devon Thorsby | April 16, 2020

Follow these steps to make your move safer during the COVID-19 pandemic.

How Much Do Septic Tanks Cost?

Devon Thorsby | April 14, 2020

Expect to pay at least a few thousand dollars to replace or install a septic tank or entire septic system.

Tips for Living in a Small Apartment

Devon Thorsby | April 9, 2020

Here's how to make the best of a small apartment while staying at home.