How can I use my 401(k) for a down payment?

For many would-be homeowners, the down payment is the biggest barrier to buying a house.

If you’re having trouble gathering funds for a down payment, you might consider using your 401(k) retirement fund as a convenient source of cash. While you can use a 401(k) for a down payment, there are pros and cons to doing this.

What is a 401(k) and how does it work?

Before diving into whether you should use your 401(k) to buy a house, it’s important to have a firm grasp on how a 401(k) retirement account works.

Your 401(k) is an earmarked savings account created specifically to help you prepare for retirement. 401(k) holders can claim a tax deduction and will see their contributions to the account accrue tax-free interest over time. The trade-off is that access to the account is strictly limited.

Early withdrawal rules

Withdrawals from a 401(k) should not be made before the account holder turns 59½ years old, or before they turn 55 and have left or lost their job.

Early withdrawals incur a 10% early withdrawal penalty on the amount of money being taken out of the account. This amount also immediately becomes subject to income tax, since it’s no longer in the protected retirement savings account.

While these regulations may seem harsh, they are in place to incentivize account holders to set aside enough money to support a comfortable retirement. That being said, it’s not illegal to withdraw money from your 401(k) early, and those funds can certainly be put toward a down payment on a house.

How to withdraw from a 401(k) to buy a house

If you do decide to withdraw from your 401(k) to buy a home, there are two options available.

1. Borrow a 401(k) loan

The first option is to obtain a 401(k) loan. This is the better of the two options. Not only do you avoid the 10% early withdrawal penalty, but the amount you withdraw will not be subject to income tax.

There are other benefits to a 401(k) loan as well. It doesn’t count toward your debt-to-income ratio (DTI), and it won’t be counted by credit bureaus. So, taking a 401(k) loan won’t hurt your credit score and won’t affect your odds of qualifying for a mortgage.

What to know before obtaining a loan

Depending on the employer plan, the maximum amount allowed to be withdrawn from a 401(k) loan can vary, but it’s usually $50,000 or less. It must be paid back with interest, typically between 1%-2%. Some provisions may exist that don’t allow you to contribute further funds to your 401(k) until your loan is repaid. That means your employer won’t be matching any contributions, either.

Taking out a loan essentially puts a freeze on your 401(k) until it’s been paid in full. Depending on how long that takes, you could miss out on years of growth.

Not all employers offer 401(k) loans as an option in their retirement plans, though. It’s also important to note that you are still required to repay the loan even if you leave your current job or are laid off. In fact, your repayment period shortens once that happens, and the loan must be repaid in full by the next tax filing date.

If you can’t make this due date, then the loan amount becomes a 401(k) withdrawal in the eyes of the IRS. That means you’ll have to pay income taxes and a 10% early withdrawal penalty. So, before taking out a 401(k) loan, make sure your career is stable.

2. Make a 401(k) withdrawal

Your second option would be to make a direct 401(k) withdrawal for your home purchase. As mentioned above, this is the less desirable of the two options.

Depending on what’s in your plan, an early withdrawal could be classified as a hardship withdrawal. Some plans may allow for an early withdrawal without a hardship.

What to know before making a withdrawal

The Internal Revenue Service (IRS) considers any emergency removal of funds from a 401(k) to cover “an immediate and heavy financial need” as a hardship withdrawal. Whether or not the purchase of a home using your 401(k) counts as a hardship withdrawal is a determination that falls to your employer, and you’ll need to present evidence of hardship before the withdrawal can be approved.

Regardless, you will still likely incur the 10% early withdrawal penalty. There are exemptions in place for specific circumstances, including home buying expenses for a primary residence. If you possess other assets that could be used for your home purchase, then you likely won’t qualify for an exemption. Even if you do, your withdrawal will still be taxed as income.

A note about the CARES act

Signed into law on March 27, 2020, the $2 trillion Coronavirus Aid, Relief and Economic Security Act (CARES) emergency stimulus bill was drafted to help those affected by the coronavirus pandemic. Under the CARES Act, 401(k) account owners could make a hardship withdrawal of up to $100,000 without paying the 10% penalty. The bill also granted the account holder 3 years to pay the income tax, rather than it being due within that same year.

The national emergency ended in April 2023. Please contact your 401(k) provider with questions.

Should I use my 401(k) to buy a house?

There are good reasons for not using your 401(k) to buy a house. Even if you’re comfortable with the 10% early withdrawal penalty, you will still be incurring long-term consequences by reducing your savings. That, in turn, can damage your future growth potential.

Let’s take a look at an example. If you take out $10,000 from a $20,000 401(k) account, you’ll only have $10,000 that will continue accruing interest. With a 7% annualized rate of return, that $10,000 could become $54,000 over 25 years—compared to $108,000 had you not withdrawn the $10,000.

Withdrawing from your 401(k) account is essentially taking out a loan against yourself. If you want to pay it back, you also need to pay interest, and the time spent paying it back is time that could have been spent growing the money in the account.

Alternatives to using your 401(k) to buy a house

Even if you’re short on cash and facing hardship, there are other options you might want to consider before tapping into your 401(k) account to cover the down payment on a house.

IRA account

If you have an Individual Retirement Account (IRA), you should look there for extra funds before considering an early withdrawal from your 401(k). IRAs are built with special provisions for first-time home buyers, which the IRS defines as anyone who hasn’t owned a primary residence within the previous 2 years.

If you’re thinking about using funds from your IRA to purchase a house, there are a few rules to keep in mind. First-time home buyers are allowed to withdraw up to $10,000 without incurring the 10% penalty. However, that $10,000 is still subject to state and federal income taxes. If your withdrawal exceeds $10,000, then the 10% penalty is applied to the additional distribution.

Consider a roth IRA

A Roth IRA may be an even better option, if you have one. Some plans allow you to make a hardship withdrawal, and up to $10,000 can be withdrawn for the express purpose of buying your first home. You’re also accessing a great tax benefit since Roth IRA contributions are taken out before you’re taxed and you don't normally pay tax on distributions outside the penalty amount for a first-time home buyer.

FHA loan

A Federal Housing Administration (FHA) loan is a government-backed mortgage loan that can make it easier for first-time home buyers to achieve homeownership. FHA lenders have looser borrower qualifications compared to other loan options, including low down-payment options and more flexible credit score requirements. For this reason, an FHA loan may be a better option than making a withdrawal from your 401(k).

FHA loans require a minimum down payment of 3.5%, but only if your credit score is 580 or higher. If your score is between 500 – 579, then the minimum down payment is 10%. With Rocket Mortgage^®, the minimum credit score requirement for an FHA loan is 580.

The cons of FHA loans

There are a couple caveats to consider for an FHA loan. First, you need to qualify for one. This process involves your prospective home being reviewed by an FHA-approved appraiser. The home must also be your primary residence and you must occupy it within 60 days of closing the purchase.

Additionally, FHA loans require the borrower to have mortgage insurance for the life of the loan, or for 11 years if you made at least a 10% down payment.

FHA loan mortgage insurance includes a 1.75% upfront premium charge and an annual premium — anywhere from 0.45% to 1.05% — based on four factors:

• Mortgage term
• Loan-to-value ratio (LTV)
• Total mortgage amount
• Size of your down payment

VA Loan

If you are an eligible service member, veteran, or surviving spouse, then a Department of Veterans Affairs (VA) loan could be a better alternative to withdrawing from your 401(k) account.

Like an FHA home loan, a VA loan is government-backed and includes lower interest rates and more flexible terms. The one major difference is that a VA loan requires no down payment.

In order to qualify for a VA loan, you must satisfy at least one of these criteria:

• Served more than 6 years with the National Guard or Reserves or at least 90 days under Title 32 with 30 of those days being consecutive
• Served 90 consecutive days of active service during wartime
• Served 181 days of active service during peacetime
• Are the spouse of a service member who lost their life, either in the line of duty or as the result of an injury gained during their active service
• Veterans discharged by reason of disability have their service time requirements waived

If you meet one of these requirements, you can obtain a Certificate of Eligibility (COE) for a VA loan by demonstrating proof of service as a veteran, active member, or spouse. The type of proof required varies depending on which category you fall into.

Buying a house with your 401(k): FAQs

You might have more questions if you’re thinking about using your 401(k) funds to buy a house. Let’s jump into some FAQs.

How much of my 401(k) can I use to buy a house?

Depending on what’s in your plan, you could take out up to $50,000 from your 401(k) account balance to put toward a down payment on a house. Basically, you’re taking out a loan against yourself when you withdraw from your 401(k), so you’ll have to pay the money back with interest. You also won’t be allowed to contribute additional funds to your 401(k) until you’ve paid back the money you borrowed. 

When can I withdraw from a 401(k) account without a penalty?

You can withdraw funds from your 401(k) and avoid the early withdrawal penalty when you turn 59½ years old. You can also tap into your 401(k) before you turn 55 if you left or lost a job.

Can I use my 401(k) to buy a second home?

You can use the money from your 401(k) to purchase a second home. However, you’ll have to pay taxes on the amount you took out of your 401(k). If applicable, you might also be subject to the early withdrawal fee. Again, this all depends on what’s in your plan and if you are required to pay hardship fees or not. Check to see what requirements you must follow.

The bottom line on using a 401(k) to buy a house

Your 401(k) account may seem tempting as an untapped source of cash, especially if you’re trying to come up with the money for a down payment on your new home. This can be a viable option, and there are ways to mitigate the penalties, it should only be used as a last resort.

Consider applying for a low down-payment loan like an FHA or VA loan, or withdrawing from your IRA.

Whatever you decide, consult with a mortgage specialist before committing to an option. Rocket Mortgage has experts waiting to help you navigate the home buying process. If you’re ready to take the next step toward buying a house, start your mortgage application today.