Soaring house prices are making it even harder for first-time homebuyers to get into a local property market already desperately short on affordable options. House prices in western Washington are up 16.4% in the year and, with interest rates set to keep rising, mortgage terms are tightening too. Home buying has never been more of a challenge!
But is it worth cracking your retirement nest egg to get a foot on the property ladder? While the tough housing market has some families looking at using a 401(k) for a down payment, first-time homebuyers do have other options.
NEST OR NEST EGG?
With the average age of first-time homebuyers going up, many millennials and others holding down a good job are being tempted to break into their 401(k) account to make a down payment on a home. After all, if house prices continue to rise the way they have been, it’s an investment that is going to outperform anything your retirement account is likely to do, right?
The fact is, while it is possible to use funds withdrawn from a 401(k) for all or part of a house down payment, it’s an expensive option that comes with significant downsides. Still, it’s your money — with some strings attached — so let’s take a look at what cracking your 401(k) entails, and also consider some alternatives.
Retirement Rules Matter
A 401(k) plan is money earmarked for retirement. The government gives you a tax break on your contributions, but, in return, it limits your access to all that cash until you’re almost 60. To dip into your money before then you will likely:
Pay a 10% early withdrawal penalty
Be taxed on the amount as income
That said, you do have some other options to consider.
Option 1: 401(k) Loans
If you are going to access your retirement savings early, the more desirable way to do it is with a 401(k) loan, an option offered by some retirement plan providers. Taking a loan allows you to avoid the early withdrawal penalty and you will not be taxed on the loan amount.
However, this option does come with its drawbacks:
Loan terms are usually limited to five years
You will have to pay yourself back, with interest
You might not be able to contribute to your 401(k) till you repay the loan
How much can you borrow from your 401(k)? Usually an amount up to half your vested account balance or $50,000 — Be sure to investigate what you 401(k) plan offers for options as each plan differs.
Option 2: 401(k) Withdrawals
If you want to tap more than $50,000 from your retirement account, your only option might be a straight withdrawal from your account. If you choose to go this route, be aware that:
You are limited to taking the amount you need to satisfy your particular financial need
You will likely be charged a 10% withdrawal penalty unless you can show hardship
You will owe taxes on the amount you receive
On the positive side, with a withdrawal, you will at least be able to continue matched, tax-free contributions to your 401(k) from your paycheck.
In both these cases, however, the long-term damage is to your retirement principal — and its potential for future growth. While the value of your house will likely continue to rise, to use that money for retirement you would need to sell your home, and be taxed on the proceeds.
With this in mind, it’s worth considering whether there are better alternatives within your reach for making that crucial first down payment:
If you have rolled over funds into an IRA account, it might be easier to tap this money. IRAs are taxed differently than 401(k)s, and IRA withdrawals, or distributions, are also handled differently. With an IRA, you might be able to:
Withdraw up to $10,000 without a 10% penalty for a first-time home purchase
Withdraw up to $10,000 tax-free for a first-time home purchase
Withdraw contributions without penalty due to financial hardship
Check the rules of your plan and the IRS rules for IRA distributions to see if you might qualify for these exemptions.
Roth 401(k) accounts are used for after-tax contributions. If you have a Roth account, you might qualify for more lenient rules for withdrawals. For instance, it might be possible to withdraw from your contributions early without facing taxes or a withdrawal penalty, provided you do not take more than the total of your contributions and begin to tap into your untaxed earnings.
Before tapping into your retirement savings, be sure you have checked more traditional sources of help for first-time home buyers.
Talk To Your Family
Family members might be willing to gift you money for a down payment, especially if this will help protect your retirement savings. This has specific tax advantages. For instance, the IRS allows tax exclusions on gifts of up to $16,000 if used for a down payment.
Explore Low Down Payment Loans
The federal government offers several loan programs to encourage homeownership. These include programs run by the Federal Housing Administration (FHA) and Veterans Affairs (VA). The FHA program offers loans with down payments as low as 3.5% and typically has less stringent credit requirements. If you’re a first-time home buyer, you can put as little as 3% down and may still be able to qualify for conventional financing.
It’s worth talking to smaller local lenders, including credit unions like Fibre Federal Credit Union, who are more willing to take their members’ specific financial situation into account when offering financing for a first home.
GETTING TO KNOW YOUR MORTGAGE OPTIONS
Buying your first home is always going to be a big investment and it comes with major implications for your financial future. Before using your 401(k) for a down payment or going in another direction, it helps to be able to talk to someone who understands your financial situation.
Fibre Federal understands the importance of homeownership. We work with our members to find the best options for them in financing a new home. We offer:
Lower down payment options
Lower rates of fixed loans compared with many other lenders
Repayment terms that work best for you
If you’re worried about making a down payment on a new home, give us a call to talk through your options or visit our site to learn more.