2 Pros and Cons of Tapping Your 401(k) To Buy a Home — Is it a Smart Investment?
Written by
Yaël Bizouati-Kennedy
Edited by
Nicholas Morine
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It’s no secret that the road to homeownership has been arduous for many Americans as of late. High mortgage rates, sky-high home prices and low inventory have left many would-be homebuyers frustrated.
Yet, some would-be buyers are choosing to remedy these hindrances and achieve their dream of homeownership by tapping into their 401(k)s.
The latest BMO Real Financial Progress Index (via PRNewsWire) found that among those who do plan to buy a home, nearly one-third (30%) say they plan to pull money from their 401(k) to help cover the cost.
“Given the higher inflationary environment the last few years, rising home prices, and elevated mortgage rates compared to the historic lows during the pandemic, it’s not surprising to me that more people are feeling a strain with their finances and looking for various ways to help offset the cost of buying a home,” said Tom Parrish, head of U.S. retail lending at BMO.
Yet, Parrish noted that that 30% figure is higher than similar consumer surveys over the last several years, which may signal that some people have less cash on hand than they used to.
“It’s crucial for people to consult a qualified mortgage advisor to help determine how much house they can afford and what a suitable monthly budget would be to stay on track toward goals and make real financial progress,” added Parrish.
But is that financially sound — and are there any risks?
Pros of Tapping Into Your 401(k) To Buy a Home
According to Parrish, everyone’s financial situation is unique and different, so it really depends on your circumstances, goals, and priorities as to whether it’s a good or bad idea to use your 401(k) toward a home purchase.
“That’s why it’s so important to work with a mortgage advisor who can assess your situation, help determine what a suitable budget and monthly payment would be, and how much you need to put down,” he said.
Parrish added that an “obvious pro” is, if you can borrow with a 401(k) loan that you are comfortable paying back over time, it frees up more cash immediately to use toward your down payment or closing costs. Said cash could also simply act as a monthly cushion when you become a homeowner — hopefully without an early withdrawal penalty.
“Typically, you can borrow up to 5% of your vested balance or $50,000, whichever is less,” he said. “But it is critical to remember that you’ll be paying that back into your plan with interest, so it’s essential to work that into your monthly budget.”
He also noted that some 401(k) plans allow for penalty-free withdrawals for first-time home purchases. You’ll still owe income tax on that amount, but you’d avoid the 10% early withdrawal penalty if you’re under a certain age.
Cons of Using Your 401(k) To Buy a Home
On the other hand, Parrish said that a disadvantage of choosing to borrow against a 401(k) is that if you leave your current employer, you may have to repay the loan in a short amount of time. If you can’t, you’ll owe a 10% penalty and taxes.
“Plus, you’re losing out on investing the money toward your retirement,” he said. “Ultimately, if you’re able to save for a home without pulling from your 401(k), such as utilizing a high-yield savings account, that is more ideal.”
What Are the Drivers?
Compared to the historic mortgage rate lows of 2020 and 2021, elevated rates are affecting how much people can afford when it comes to a monthly payment — as well as the myriad of expenses that comes with homeownership, per Parrish.
In addition, rising home prices are pushing prospective buyers into a heftier down payment.
“So, to help cover that gap, some are turning to 401(k) loans,” he said, adding that it’s clear many Americans have depleted most of their personal savings due to rising everyday prices — most notably excess pandemic savings.
Why Is This Method More Prominent Among Younger Generations?
Another finding of the BMO Real Financial Progress Index? Younger Americans are more likely to pull money from their 401(k) for a home purchase.
Millennials (31% of those polled) and Gen Zers (34% of those polled) were more likely to say they will pull out money early, as compared to Gen Xers (25%) and baby boomers (16%).
Expensive rent, student loan payments, and simply being less established in their careers may have harmed their savings — and in turn, their ability to afford a down payment, according to Parrish.
Finally, Parrish said before considering using your 401(k) as an option to cover the cost of a house, a mortgage specialist would be able to advise aspiring homeowners on the options that may be available, such as first-time homebuyers grants and programs to help offset the cash they need to bring to closing.
Funding your retirement account early is crucial to making long-term financial progress, he noted.
“So it’s important that, younger people especially, thoroughly review their finances, determine a suitable budget and have a good understanding of everything that comes along with homeownership — in addition to having a clear picture of repayment terms on a 401(k) loan before moving forward with that as an option,” he said.
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