March 11th, 2014
We’ve been seeing this question asked a lot lately. It’s a tough question to answer because everyone’s situation is different.
So today, we’ll look at the pro’s and con’s and help you think about the important questions to make up your own mind if it’s the right thing for you.
Generally speaking, we’re not talking about savings. We’re talking about your 401k investments, IRA’s and other investments you may have specifically set aside for retirement.
Borrowing from your IRA’s is not like borrowing from your 401k. You have 60-days to pay back the IRA loan without penalty. You can borrow from your 401k for five-years without penalty as long as it’s all paid back before the five years have elapsed.
You can usually borrow up to half of your 401k balance up to a maximum of $50,000 at any age and for any reason.
If you’re young, you can withdraw money from an IRA for a first time home purchase subject to a lifetime limit of $10,000 as of June, 2013. Talk to a reputable tax adviser if this is something that you’re looking into.
Both of these will give you extra cash when you may need it most, like closing costs or getting a slightly higher down payment. The IRA would be interest free if you pay back without incurring penalties and 401k would charge the prime rate plus one or two percentage points that goes back into your account.
Borrowing from your 401k won’t count in your debt-to-income ratio when you apply for a mortgage, and it won’t get reported to the credit bureaus.
If you borrow from your 401k and lose or leave your job, you have a 60-90 day window to pay back the loan or it will be considered a distribution subject to taxes plus 10% early withdrawal penalty if you’re under 55.
You can’t miss even one payment or else you will be considered in default and penalized.
You will get double-taxed when you repay the loan. This is because the loan repayments, including the interest, will be repaid with amounts that have already been taxed and will be taxed when withdrawn from the retirement account.
If you cash out other investments intended for retirement, you lose the benefit of holding onto it for long term, and may have to pay capital gains on your taxes.
Bottom line is talk to a tax professional to understand the impact to your taxes. Think about if the long term gain of the house will offset the lost opportunity by borrowing or cashing out your retirement investments. Will you have enough time to recover?
And finally, the bottom, bottom line is never borrow more than you can repay. Don’t borrow off of your 401k to buy a larger house and then not adjust your spending so you can’t repay the 401k every month. And remember that if you lose or change your job, you will be required to pay back the borrowed amount in full. Talk to a reputable mortgage loan officer to understand how much you can afford.