If you have a retirement savings account in the form of a 401 (k) it may be possible for you to borrow money from it. Since you are essentially borrowing from yourself, it will not impact your debt-to-income ratio, which may be an important aspect to consider if you are planning to also apply for a mortgage loan. It has become fairly common in the United States to borrow money from the 401 (k) to cover the down payment and closing costs when buying a home.
Important: Just because you have a 401 (k), you are not automatically permitted to borrow money from it. Contact your employer and/or the IRS (irs.gov) for more information.
What is a 401 (k) account?
The 401 (k) account is a company-sponsored retirement savings plan available in the United States.
It is up to the employer to decide if they want to offer this type of benefit to their employees, and it is then up to each individual employee to decide if they want to enrol or not.
If the employee enrols, a percentage of each pay check will automatically be deducted and put into their 401 (k) retirement savings account. The employer elects to match part or all of the deposited money.
For the employee, the 401 (k) have two main benefits over traditional saving accounts:
- Matching from the employer
- Different tax treatment, which may be beneficial
A downside with the 401 (k) is that the employee is limited when it comes to investment choices. A lot of different alternatives are available, but there are still limitations compared to simply saving on your own. There are also rules that must be followed if you want to “dip into” your 401 (k) savings before you retire.
Can I only borrow from my 401 (k) to buy a home?
No, this is not a requirement to be allowed to borrow from your 401 (k) savings.
With that said, borrowing from your 401 (k) to purchase a primary residence does come with certain advantages, such as a longer permitted repayment period. This is because the lawmaker wants to encourage home ownership.
The standard rule for borrowing from your 401 (k) is that the loan must be repaid within 5 years. If you fail to achieve this, it will be considered a an early withdrawal instead of a loan, and you must pay the 10% early withdrawal fee. If you borrow to purchase a primary residence however, you can be allowed to pay it back over a longer period of time than 5 years. For more detailed information, contact the IRS.
The CARES Act
The CARES Act was established as a form of Covid19 relief. Before you make any decisions about borrowing from your 401 (k) savings, we strongly recommend you check if the CARES Act apply to you, because some of the rules in this act pertain to borrowing from a 401 (k) savings plan. Among other things, the CARES Act contains certain provisions for those who wish to borrow more than what would normally be allowed. For more information, contact the IRS.