Money Rehab with Nicole Lapin - Should You Use Your 401(k) To Buy a Home?

Episode Date: January 10, 2023

A down payment on a home will probably be the biggest transaction you’ll ever make in your life… and if you’ve been diligent about contributing to your 401(k), you might be tempted to fund your down payment from that nest egg. It's allowed, but comes with strings attached. Nicole explains the 411 on using a 401(k) to buy your dream home.

Money rehabbers, you get it. When you're trying to have it all, you end up doing a lot of juggling. You have to balance your work, your friends, and everything in between. So when it comes to your finances, the last thing you need is more juggling. That's where Bank of America steps in. With Bank of America, you can manage your banking, borrowing, and even investing all in one place. Their digital tools bring everything together under one roof, giving you a clear view of your finances whenever you need it. Plus, with Bank of America's wealth of expert guidance available at any time, you can feel confident that your

money is working as hard as you do. So why overcomplicate your money? Keep it simple with Bank of America, your one-stop shop for everything you need today and the goals you're working toward tomorrow. To get started, visit bofa.com slash newprosmedia. That's b-o-f-a dot com slash n-e-w pros p-r-o-s media. bfa.com slash newprosmedia. I'm Nicole Lappin, the only financial expert you don't need a dictionary to understand. It's time for some money rehab. it's time for some money rehab. If you're one of the 40% of Americans who contribute to a 401k, you're taking key steps toward securing your financial future. Yay, you. But if one thing is clear in this cuckoo bananas world of finance, it's that expenses only get bigger as life goes on. Like buying a house, for example. If you decide that buying a home is right for you,

coming up with the money to make such a large purchase can be difficult no matter where you are in your financial journey. Especially right now, home prices are still steep in many places and interest rates are rising. Typically, the down payment on your house should be 20% of the total sale price. You can often do less, but whether or not you should is for a different conversation. So just for now, let's assume you're dropping 20% for the down payment. That means if you're looking to buy a $400,000 house, you can expect to spend $80,000 for the down payment, or even more depending on the mortgage lender or financial institution. It is a lot of money to spend at once. A down payment

on a home will likely be the biggest transaction you will ever make in your life. And if you've been diligent about contributing to your 401k, you might be tempted to take your down payment from that nest egg, which is allowed. I don't know if you knew that, but it does come with strings attached. So here's the 411 on using a 401k to buy your dream home. When looking to withdraw from your 401k, you have two options. You can choose to take a 401k loan or just simply withdraw the necessary amount from your account. Each decision, of course, comes with different pros and cons, but both are viable options. However, remember

that reducing the amount of money in your 401k, regardless of whether or not you take a loan out or you just withdraw the cash, will slow down the returns you make in your 401k account. will slow down the returns you make in your 401k account. Also, keep in mind that I am just talking about the situation where you're using this money to buy a house. If your situation is that you're looking for 50 grand to spend on a private jet to the Maldives, different rules apply. But back to your dream home. Taking a loan from your 401k allows you to access up to $50,000. A loan will help you avoid facing early withdrawal penalties, and you won't have to pay income tax on the loan amount. And that is very good news. But, and there always is a but, you'll need to repay the loan with interest. The terms at which you have to repay the loan, including the time

you have to pay it back and the interest rate, will depend on your 401k provider. Not to mention, your provider might not even allow 401k loans, but if they do, they'll likely give you a generous amount of time to pay the loan back. Usually, loan repayment options are set within five-year windows, but when it comes to buying a house, some providers will give you more time. So just to recap, the main pros for 401k loans are number one, no penalty payments or income tax. Number two, quick access to a large sum of money. And number three, reasonable repayment timelines. So those are good things, but we can't forget the cons. The biggies are, number one, you will not be able to make

contributions to your 401k until your loan is repaid. This also means, number two, no employer match while you're repaying your loan, which all adds up to number three. You will see a reduction in the amount of compound interest you will earn in your 401k because you'll have less money in that account and you won't be making contributions. Moving on to option two, withdrawing a chunk of money from your 401k. So this is really different from the loan option. You won't be responsible for repaying the sum back to your account, but there is a catch. Unless your employer determines that you're eligible for an exemption,

taking money out of your 401k early will give you penalty fees of 10% if you're younger than 59 and a half. And yes, that is the real number the government came up with. The amount will also be considered taxable income, which could bump you into a higher tax bracket for the year and add more dollar signs onto your tax bill. So at a glance, the main pros to withdrawing from your 401k are number one, no penalty fees for first-time homebuyers up to a certain withdrawal amount, typically $10,000. Number two, money does not have to be repaid to your 401k account. And of course, there's the flip side. The cons are number one, most situations will result in mandatory fees of 10%. Number two, you will be taxed on the amount you withdraw.

And number three, real estate typically has lower returns than a 401k account. So let's evaluate, shall we? Do the pros outweigh the cons for you? They don't necessarily for me. So I imagine they don't necessarily for you either. But this doesn't necessarily mean that your white picket fence dreams are lost forever. This may just mean that it would be better for your bottom line to find a house at a lower price point. Or if you don't want to make any compromises on your budget, you can give yourself a little more time to build up a down payment nest egg. There are concessions you can make, but don't make your future retired

self be the one who has to sacrifice. For today's tip, you can take straight to the bank. While you can tap into your 401k to secure the house of your dreams, it's best to explore all other options first. Certain states have special programs for first-time homebuyers, so check your local resources. The goal here is to do right by your current self and also your future badass retired self. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin. Our executive producer is Morgan Levoy. Do you need some money rehab? And let's be honest, we all do. So email us your money questions at moneyrehab at moneynewsnetwork.com to have your question

answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content. And lastly, thank you. Seriously, thank you for listening and investing in yourself, which is the most important investment you can make.