Should You Borrow From Your 401(k) to Buy a Home?

For home buyers scraping up the money for a down payment, the 401(k) plan seems like an ideal source. You can borrow up to half of the money in your plan, up to $50,000. You'll repay it with monthly payroll deductions. The loan is hassle-free, the payments are painless, and the interest goes straight to you (since you are borrowing from your own savings), not to a bank or mortgage company. What could be wrong with that? Lots, as it turns out.

You may want to think twice before raiding your nest egg to feather your nest. Here's why:

  • Borrowing from your 401(k) plan will slow its growth. When you withdraw the loan money, it reduces the amount that you have invested. Let's say your 401(k) funds have been invested in the stock market, earning double-digit returns. Once you borrow the funds, you lose that double-digit growth. If you repay the loan with interest at 9 percent, but your investments had been earning 18 percent, you cut your investment growth in half.
  • You may be tempted to reduce your monthly 401(k) contributions by the amount of your loan repayment to keep your paycheck stable. That's a mistake: your retirement assets will stagnate while your taxes balloon. Contributions to your 401(k) are tax-deductible. Your loan repayments are not, so expect the taxes deducted from your paycheck to increase.

  • Interest you pay on the loan isn't tax-deductible, unlike the interest on a home equity loan or home mortgage. So you'll pay tax on the interest twice, when you earn the money to pay the interest, and then at retirement when you receive distributions from the plan.
  • Any loan balance still outstanding when you leave your job will be treated as a withdrawal. You'll owe income taxes on the money, plus a 10 percent penalty if you are under 59 1/2.

Making the Most of It

Despite these drawbacks, your path to home ownership may require you to borrow from your 401(k) plan. If so, here are steps to take to minimize these problems.

  • Invest the funds remaining in your 401(k) plan in stocks for long-term growth. The money you owe the plan is earning a fixed rate of interest, like bonds, so counterbalance the 401(k) loan with stocks.
  • Continue making contributions to your 401(k) plan, cutting expenses to do so. You'll get further behind in your retirement saving if you reduce your contributions as well as reducing the growth in the plan through borrowing.
  • When your home appreciates, take out a home equity loan and repay the money you borrowed from your 401(k) plan. The interest on the home equity loan is tax-deductible, and the fresh money in the 401(k) plan can be invested for long-term growth.
  • You must repay the loan within a specified time, usually 30 to 90 days, if you leave your job, to avoid income taxes and penalties. Stay on the job until the loan is paid. If you must leave, explore in advance the sources you can tap to repay the loan.
Like this? Want more?
Connect with Us
Follow Our Pins

Yummy recipes, DIY projects, home decor, fashion and more curated by iVillage staffers.

Follow Our Tweets

The very dirty truth about fashion internships... DUN DUN @srslytheshow

On Instagram

Behind-the-scenes pics from iVillage.

Best of the Web