You can use your 401K to buy a house, but you must make sure that you follow the rules of the Internal Revenue Service (IRS). The IRS has the ability to assess penalties and taxes against the withdrawal of money from retirement accounts. A 401K is a retirement account that your employer offers and may make matching contributions to your fund. You should consider taking out a second mortgage on your existing home if the loan is for a second home. If the mortgage insurance and other fees associated with another type of loan is less than the expense of withdrawing from your retirement account, then it may be beneficial for you to pay the taxes and interest assessed for early withdrawal.
The moderately difficult instructions listed below will explain how you can use your 401K to buy a house. You need to determine the equity that you have in your 401K before we begin with step 1.
Step 1: The IRS rules permit withdrawal from your retirement account if you are a first time home buyer. The use of the money for a second home, as a general rule, will be penalized by taxes by the IRS and you may face penalties from the administrator of the account as well.
Step 2: Find a home which qualifies so that the down payment can be withdrawn from your 401K. You must have the equity before you can use your 401K to buy a house. Only take out what is needed. Here’s an example: You can get a mortgage for $150,000 if you have the $22,000 down payment. You can get a mortgage for $100,000 if you have the $15,000 down payment. If you have determined that you want the home for $150,000, then you will have to borrow $7,000 from your 401K to add to the $15,000 so that you will have enough and qualify for the $100,000 home. Don’t borrow the closing costs and other fees from the 401K. Take only the minimal amount that you can get by with.
Step 3: Talk to the administrator of the retirement account. You will have to pay a ten percent penalty on the early withdrawal and the money will be taxed as regular income. This will raise your adjusted gross income and can cause you to be in a higher tax paying bracket, as well.
Step 4: Look at all the alternatives for the funds before you decide on taking from the fund. Ask your employer if he can loan you the money against the 401K instead of cashing out the money. Usually you will find that you can pay a lower rate of interest on money borrowed from the retirement account than on money that is borrowed from other financial institutions. You may be able to avoid the taxes and penalties by taking out a loan instead of cashing out.
Step 5: If you can wait a few months before you purchase the home, you may find that you are in a better financial position. You can pay down the debt that you owe and lower your debt to income ratio. This may encourage a lender to take a risk on you who may have not been willing to earlier when you had a higher ratio. You can use your 401K to buy a house but you may find that other alternatives are more financially advantageous to you.