Can You Use 401k Money To Buy A House Without Penalty

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Saving up for a down payment can be a major hurdle to homeownership, especially since it isn't the only expense in the mortgage process. You might need to come up with money for closing costs, moving costs, and modifications or furnishings for your new home as well.

If you're short on cash, one way you can fund your down payment is to draw from your 401(k). However, this comes with significant drawbacks.

Here's what you need to know about using your 401(k) for a home down payment:

Can you use your 401(k) to buy a house?
How to use your 401(k) for a down payment
Drawbacks to tapping your 401(k)
Alternatives to using your 401(k) for a down payment

Can you use your 401(k) to buy a house?

Yes, you can use the money in your 401(k) to buy a house. Here's a quick review of how 401(k) accounts work:

Employees and self-employed individuals can contribute pre-tax dollars from their salaries.
Employers and self-employed individuals can also make contributions on the company's behalf.
Employers can match a percentage of their employees' contributions.

For 2021, the maximum employee contribution is $19,500. The maximum company contribution and employer match, combined with employee contributions, can't exceed 100% of your compensation, or $58,000, whichever is less.

Tip: When you withdraw money from your 401(k), you pay taxes on the full amount of the withdrawal at your current tax rate. If you're younger than 59½ (or 55, if you're no longer with your employer), you'll also pay a 10% early distribution penalty.

How to use your 401(k) for a down payment

While it's possible to fund a down payment from a 401(k), it's generally not recommended. Still, if you want to proceed, there are two main ways:

Borrow against your 401(k)
Make a withdrawal from your 401(k)

These are the key differences between 401(k) loans and withdrawals:

401(k) loan	401(k) withdrawal
Must be repaid, with interest	Can't be repaid
Amount limited to the lesser of 50% of your vested account balance up to $50,000	Can't exceed the amount needed to purchase your home
Might become due in full if you lose or leave your job	Not affected by losing or leaving your job
Not taxable unless you fail to repay it	Income tax is due on the amount withdrawn
No tax penalty unless it isn't repaid	Might incur a 10% early withdrawal tax penalty
Might not be able to make new contributions during loan repayment	New contributions can be made after

Borrow against your 401(k)

Borrowing from your 401(k) is generally the more advantageous option if you want to tap your plan for a down payment.

If your employer's plan allows employees to take out loans against their 401(k) accounts, you'll typically be able to borrow up to 50% of your vested account balance or $50,000, whichever is less.

Tip: If your balance is $10,000 or less, you might be able to borrow up to your entire balance.

You'll then have to make more or less equal payments — at least quarterly, with interest — until you've repaid the loan. You'll typically need to repay it within five years.

Upsides

No withdrawal penalty
Won't affect your credit

Downsides

You'll have to pay yourself back
Can affect your home loan qualification by hurting your debt-to-income ratio

Learn More: 401(k) Loans: Should You Borrow Against Your Retirement?

Make a withdrawal from your 401(k)

A withdrawal is generally a worse option when it comes to tapping a 401(k) for a down payment.

If your employer's plan allows for hardship distributions, the IRS allows individuals to take early withdrawals before age 59½ as a result of an "immediate and heavy financial need," such as buying a home.

While buying a home might not sound like a hardship, that's how the IRS regulates these types of distributions.

You won't have to — or even be allowed to — repay the money you take out. You'll pay regular income tax on the amount withdrawn, and if you're younger than 59½, you'll also owe a 10% early withdrawal tax penalty.

Upsides

Doesn't have to be repaid
Won't affect your debt-to-income ratio

Downsides

Taxes and the 10% early withdrawal penalty reduce the amount available to put toward your home
Permanently reduces your retirement savings

Drawbacks to tapping your 401(k)

There are a few scenarios where tapping your 401(k) for a down payment might make sense. For instance, you might consider it if you want to:

Capitalize on rapidly appreciating home values and/or low interest rates
Build equity sooner
Obtain a more affordable mortgage payment
Secure a home before you're priced out of the market

However, it's generally not recommended to use your 401(k) funds to buy a house, even if the situation appears ideal.

Whether you're borrowing from your plan or taking a hardship distribution, the decision could have an enduring impact on your retirement savings.

Example: Your account balance will be lower, and that means any returns you generate will be smaller too. Six percent of $100,000 is $6,000, but six percent of $50,000 is only $3,000 — and the effect compounds over time.

If you're taking out a 401(k) loan, you might miss out on years of additional contributions and employer matching.

And, if you lose or leave your job, you might have to quickly repay the rest of your loan to avoid having it count as an early distribution that'll be taxed and penalized.

Learn More: How to Save for a Down Payment on a House

Alternatives to using your 401(k) for a down payment

There are more financially secure ways to speed up your path to homeownership than using your 401(k). Here are four alternatives to look into.

1. Tap your IRA or Roth IRA instead

Best for: First-time homebuyers who need $10,000 or less for a down payment

You normally need to be 59½ to take penalty-free distributions from your IRA, but the IRS allows an exception for qualified first-time homebuyer distributions.

As long as you put any early distributions of up to $10,000 toward buying or building your first home, you won't have to pay the additional 10% tax on it.

Read On: First-Time Homebuyer? Here's How to Get the Money for Your Down Payment

2. Get a government-backed mortgage

Best for: Borrowers with low credit scores and at least 3.5% down

An FHA loan allows you to put down as little as 3.5% with a credit score of 580 or higher. You can finance the closing costs and upfront mortgage insurance premiums, which means you don't need to have a lot of cash on hand.

3. Get a low-down-payment conventional mortgage

Best for: Borrowers with good credit and at least 3% down

With a credit score of at least 620, you can get a low-down-payment conventional loan. Specifically, you might want to look into loans geared toward first-time homebuyers. These include Fannie Mae's HomeReady or Standard 97 loans, or Freddie Mac's Home Possible and HomeOne loans.

If you're considering a home purchase, be sure to shop around for the best rates. Credible makes this easy — you can compare multiple lenders and receive prequalified rates in as little as three minutes.

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4. Look into down payment assistance programs

Best for: Low- to moderate-income borrowers who can't afford a down payment

Programs for first-time homebuyers are available from state housing finance agencies, local nonprofit organizations, federal agencies, local governments, and other entities.

These programs provide down payment assistance in the form of grants, no-interest loans, forgivable loans, and the opportunity to earn sweat equity.

Learn More: 5 Types of Mortgage Loans: Which One Is for You?

About the author

Amy Fontinelle

Amy Fontinelle is a mortgage and credit card authority and a contributor to Credible. Her work has appeared in Forbes Advisor, The Motley Fool, Investopedia, International Business Times, MassMutual, and more.