How to use a 401(k) loan for a home purchase
Eden Villalovas
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Certain retirement plans allow people to take a loan from their 401(k), using that money to cover large expenses such as a home down payment or closing costs.
Other uses for a 401(k) loan include paying off high-interest debt, medical bills, education costs, and more.
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To check if a plan offers loans, the plan sponsor or the summary plan description should contain that information, according to the IRS.
A favorable option is to apply for a 401(k) loan, which avoids a 10% early withdrawal tax penalty because the applicant is borrowing from themselves, so the amount is not taxed as regular income.
Withdrawing funds from a 401(k), instead of taking out a loan, before age 59 1/2 could have a 10% early withdrawal tax penalty. However, individuals can avoid this fee if the home purchase is considered a hardship distribution, which the IRS defines as a withdrawal “made because of an immediate and heavy financial need.”
The first step in taking out a 401(k) loan is to speak to your employer and contact the company’s human resources representative or 401(k) plan representative. From there, applicants may be able to apply online, depending on the paperwork and information they received from their employer. After consulting with the company, the lender will determine your loan coverage through factors like credit score or loan approval odds.
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The maximum borrowed amount that can be taken from a 401(k) is typically $50,000 or half your vested balance within a 12-month period, according to the Annuity Expert. Repayments commonly occur for up to five years with interest, and borrowers have to make a payment quarterly.
After the loan is approved, borrowers should continue to make regular retirement plan contributions and schedule payments.