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Can I Use a 401k to Buy a House?

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  • Can I Use a 401k to Buy a House?

    After contributing money to a 401k plan over many years, some people have a large amount of money inside of a 401k account. These accounts can be a desirable source of funds for purchasing a home. However, there are rules and restrictions on withdrawals from a 401k account. Fortunately, there may still be a way for some people to use the money in their 401k.

    Some 401k plans allow participants to take a loan against the funds within the 401k. Typically, the plan will limit the amount of the loan to a certain percentage of the total account balance. The means that you can't borrow all of the money in your plan, just some of it. However, this amount may still be significant enough to be useful for your long-term goals.

    When you borrow money from a 401k plan, you borrow the money from yourself. In other words, the funds are withdrawn from your account and distributed to you. That means there is no credit check and your credit score has no impact on your loan interest rate, because there is no risk to any creditor. You are paying back yourself. In fact, the interest you pay on the loan goes directly into your own 401k account, not to any bank or lender.

    However, this doesn't mean you can control how and when you repay the loan. The IRS has requirements that must be met regarding 401k loans. As such, the plan will have a set interest rate that you must pay when you repay the loan. In addition, you must make timely, regular payments, just like any other loan. Typically, most 401k plans require that you make regular monthly payments in order to fulfill this requirement.

    It is important that you make your 401k plan loan payments. While there are no creditors involved, and therefore there is no damage to your credit rating or credit report, there can be substantial tax repercussions for failing to repay the loan as agreed. Any loan principal that is not repaid is considered a distribution by the IRS. That means that the full amount of any unpaid loan balance is taxable as ordinary income. Even worse, if you are under age 59 1/2, then the distribution will be considered an early distribution and may be subject to a 10 percent tax penalty.

    The benefits of using a 401k plan loan to buy a house are very advantageous to most people. However, it is important to understand that even though it is a loan to yourself, it is still a real loan, and it must be repaid. If you can do that, then borrowing from your 401k may be a smart way to finance your home purchase.

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