Using your 401(k) or IRA for a down payment: what it costs

Saving for a down paymentdown paymentThe down payment is the part of the home's price you pay out of your own pocket when you buy; the loan covers the rest. In U.S. Spanish it is also called enganche, cuota inicial or entrada. Each loan type has its own minimum: FHA requires at least 3.5% of the value, VA and USDA loans may require none, and conventional loans ask for more if you want to avoid private mortgage insurance. A larger down payment lowers the loan, the monthly payment and the total interest; many state programs help families put it together.See the full definitionClose takes years. If you have money in a workplace retirement plan, such as a 401(k), or in an IRA, it is natural to think about using it. The law allows it in several cases, but each path has a different cost: income tax, a 10% additional tax or payments that come out of your paycheck. This guide explains the three paths with the IRS rules and what the lender looks at, so you can run the numbers before you move your money.¹

The most you can take from your IRA over your lifetime for your first home without the 10% additional tax

$10,000³

The time you have to use that money on the purchase after you receive it

120 days³

The usual time to repay a 401(k) loan; for your principal residence it can be longer

5 years⁵

Three paths and what each one costs

Before age 59½, taking money out of a retirement account generally costs you a 10% additional tax on the part that counts as income. That applies to IRAs and to workplace plans.¹² For buying a home there are three ways out, and only one avoids that 10%:

• The IRA first-home withdrawal. Up to $10,000 over your lifetime without the 10% additional tax.³
• A 401(k) loan. It is not a withdrawal: you borrow your own money and pay it back with payments.⁵
• A hardship withdrawal. It leaves the plan for good, is taxed and may owe the 10% additional tax.⁶

The first-home exception does not work for a 401(k). In the IRS table, it applies to IRAs and not to qualified workplace plans.⁴ Many people mix this up and get a surprise at tax time.

The three paths, side by side

No 10% additional tax

IRA withdrawal for your first home

• Up to $10,000 over your lifetime, per person
• You use it on the purchase within 120 days
• With a traditional IRA you still pay income tax
• It is not put back, unless the purchase falls through

You repay it

401(k) loan

• Only if your plan offers loans
• Up to the maximum the law sets
• Payments at least quarterly, generally over 5 years
• If you stop paying, the balance becomes a taxable distribution

Gone for good

401(k) hardship withdrawal

• Only if your plan allows it
• Limited to what you need for the purchase
• Taxed, and may owe the 10% additional tax
• Cannot be repaid or rolled over to an IRA

Get your plan's rules in writing and compare how much reaches your hands on each path.

The IRA withdrawal for your first home

The IRS lets you take up to $10,000 from your IRA to buy, build or rebuild a first home without paying the 10% additional tax, even if you are under 59½. These are the conditions:³

• The deadline. You use the money to pay the costs of the purchase before the close of the 120th day after you receive it.
• For whom. The home must be the main home of a first-time homebuyer: you, your spouse, or your or your spouse’s child, grandchild, parent or other ancestor. So you can help a child with a first home.
• The limit. All your first-home withdrawals, over your whole life, cannot exceed $10,000. If you and your spouse are both first-time homebuyers, each of you can take up to $10,000.

Who is a “first-time homebuyer”? To the IRS it does not mean you never owned a home. Generally, it is someone who had no present interest in a main homeprincipal residenceYour principal residence is the home where you live permanently and spend most of the year. According to FHA, a person can have only one principal residence at a time. Lenders tell it apart from a second home, which you occupy in addition to your principal residence but for less than most of the year, and from an investment property, which you own but do not live in. Fannie Mae buys loans on all three, but it applies a loan-level price adjustment (LLPA) to loans on investment properties.See the full definitionClose during the 2 years before the date of acquisition. If you are married, your spouse must also meet this. The date of acquisition is the day you sign a binding contract to buy, or the day construction begins. The money can pay for the purchase and usual or reasonable closing costsclosing costsClosing costs are all of the costs you pay on closing day on top of the down payment: lender fees, the appraisal, the credit report, title insurance, the closing agent's fees, any transfer taxes your state or county charges and the first deposits into the escrow account. The lender must itemize them on the Loan Estimate within days of your application and confirm them on the Closing Disclosure before you sign. Some can be paid by the seller, and several state programs help cover them.See the full definitionClose.³ This definition is the IRS’s; assistance programs may use another one to decide who is a first-time buyerfirst-time homebuyerUnder the definition HUD uses, a first-time homebuyer is a person, and his or her spouse, who has not owned a home during the three years before the purchase. There are exceptions: a single parent or a displaced homemaker is not excluded just because he or she owned a home with a spouse while married. Nor does it count if you only owned a home that was not on a permanent foundation, or one that did not meet building codes and could not be brought up to code for less than the cost of building a new one. Each program may use its own definition.See the full definitionClose.

If the purchase falls through. If the purchase is canceled or delayed, you can generally put the money back into an IRA within 120 days without paying income tax or the 10% additional tax.³ Write down the date you received the money.

Traditional or Roth IRA: not the same

With a traditional IRA, the exception only removes the 10% additional tax. The money you take out generally counts as income that year, and you pay income tax on it.³ Federal income tax is also withheld from IRA withdrawals unless you elect out; if you do, you may owe more when you file.¹

With a Roth IRA, money comes out in order: first your regular contributions, then conversions and last earnings. Your regular contributions do not count as income. Earnings do not either, if the withdrawal is qualified: the 5-year period since your first Roth contribution must have passed, and it must meet a condition such as the first-home rules, with the same $10,000 lifetime limit.³

A loan from your 401(k)

A 401(k) loan is not a withdrawal: you borrow your own money and pay yourself back with interest. These are the IRS rules:⁵

• Your plan decides. A plan may offer loans, but it does not have to. IRAs do not allow loans.
• How much. The most is the lesser of $50,000 or the greater of $10,000 or 50% of your vested balance (the money that is already yours).
• How you repay. Generally over 5 years, in equal payments of principal and interest, at least quarterly. If the loan is to buy your principal residence, the plan can give you more than 5 years.

The big risk is falling behind. If you do not pay according to the terms, the unpaid balance is generally treated as a taxable distribution.⁵ Before age 59½, that can add the 10% additional tax. If you leave your job or the plan ends, many plans reduce your account by what you owe. In that case, the IRS gives you until your tax return due date, including extensions, to roll that amount into another plan or an IRA.⁵ Ask your plan what happens to your loan if you change jobs.

Think about your budget too. The loan payment comes out of your paycheck at the same time you start paying the mortgage. The how much house can I afford calculator helps you see whether both payments fit.

The hardship withdrawal

Some plans allow a hardship withdrawal. The plan does not have to offer it. It must be due to an immediate and heavy financial need and limited to what you need. Costs directly related to buying your principal residence count as that need; mortgage payments do not.⁶

The cost is high:⁶

• It is subject to income tax, except the part that comes from Roth contributions.
• It may owe the 10% additional tax, because the first-home exception does not apply to a 401(k).
• You cannot put it back in the plan or roll it into another plan or an IRA. That money stops growing for your retirement.

Example with real numbers

A couple thinking about using their traditional IRAs

An example in words, not a real case, of how the costs add up.

What they take out

Up to $10,000 each from their IRAs, because both are first-time homebuyers

The 10% additional tax

They do not owe it if they use the money on the purchase within 120 days

Income tax

They do owe it: the money counts as income for the year

What reaches their hands

Less than they took out, because of federal withholding

What they decide

Run the numbers with a free VITA preparer before they ask for the withdrawal

The rules in this example come from the IRS.³³ Use the savings plan to see how much you still need to save without touching your retirement.

Run it with your numbersDown payment savings plan

What the lender looks at

The lender checks where every dollar of your down payment comes from. Retirement money works, with conditions:

• With Fannie Mae. Vested money from an IRA or a 401(k) can go toward the down payment, closing costs and reservesreservesReserves are the cash and other easy-to-cash assets you still have available after the mortgage closes. They are measured in months: how many full monthly house payments (principal, interest, taxes, insurance and association dues) you could cover with them. Under Fannie Mae's rules, they include money in checking or savings accounts, investments, the vested part of a retirement account and the cash value of a life insurance policy; personal loans and the money you use to close do not count. An eligible gift can also be used. How many months are required depends on the loan and the property.See the full definitionClose. The lender checks that the account is yours and allows withdrawals even if you leave your job. If you only use it as reserves, you do not have to take the money out.⁷
• The 401(k) loan and your debts. With Fannie Mae, the lender does not have to count that payment in your debt-to-income ratiodebt-to-income ratio (DTI)Your debt-to-income ratio (DTI) is all your monthly debt payments divided by your gross monthly income, that is, income before taxes. If you pay a certain amount each month across a car, cards, student loans and the mortgage you are asking for, and you earn three times that, your DTI is one third. Lenders use it to measure whether you can manage the payment; each loan type and lender sets its own limit, and assistance programs usually publish theirs. Paying down debt before applying improves your DTI.See the full definitionClose if it has a copy of the loan document. But if you use the same account as reserves, it subtracts what you borrowed and the fees.⁸
• With FHA. The lender may count up to 60% of the value of your retirement accounts, minus any loans against them, unless you show you can withdraw more after taxes and penalties. It asks for your latest statement and the withdrawal and loan terms.⁹ Our FHA loan guide explains the rest.

Talk with your lender before you move the money. That way you know which papers it will ask for and when it makes sense to take the withdrawal or the loan. Our guide Cash savings and your mortgage explains how to document your savings.

Before you take money out of your retirement

1. 1. Find out which account you have

   Today

   Traditional IRA, Roth IRA, 401(k) or 403(b): each has different rules.⁴

2. 2. Get your plan's rules in writing

   This week

   Ask whether it offers loans or hardship withdrawals, how much, and what happens if you leave your job.⁵

3. 3. Check whether you are a first-time homebuyer

   Before you sign the contract

   Count the 2 years before the contract date, for you and your spouse.³

4. 4. Ask your lender how it counts the money

   Before you move the money

   Which statement it needs and how it counts a 401(k) loan payment.⁸

5. 5. Take the money out on time

   Close to closing

   From the IRA withdrawal, use it on the purchase within 120 days.³

6. 6. File correctly the next year

   On your tax return

   Check the code on your 1099-R; if it does not show the exception, file Form 5329.¹

If this is you

It is your first home and you have an IRA

You can take up to $10,000 without the 10% additional tax if you use it on the purchase within 120 days.³

You want to help your child with a first home

Your IRA exception also works for your child's or grandchild's first home.³

You owned a home a long time ago

You can count as a first-time homebuyer if you had no main home in the last 2 years.³

You are self-employed and have an IRA

IRAs do not allow loans; the way out is the withdrawal, with its taxes.⁵

Your plan only offers hardship withdrawals

They are taxed, may owe the 10% additional tax and cannot be repaid; compare with down payment assistance first.⁶

You may change jobs soon

Ask what happens to your 401(k) loan; if it is not repaid, it becomes a taxable distribution.⁵

Mistakes that cost you

• Mistake: Believing a 401(k) has the first-home exception.

  Instead: That exception is for IRAs; from a 401(k) the withdrawal may owe the 10% additional tax.⁴

• Mistake: Thinking that without the 10%, a traditional IRA withdrawal costs nothing.

  Instead: It generally counts as income and you pay income tax on it.³

• Mistake: Taking the money out months before you have a contract.

  Instead: You have 120 days to use it on the purchase; take it out once the closing date is clear.³

• Mistake: Taking a 401(k) loan without asking what happens if you leave your job.

  Instead: If it is not repaid, the balance can become a taxable distribution.⁵

• Mistake: Taking more than you need as a hardship withdrawal.

  Instead: It must be limited to what is necessary, and you cannot put it back in the plan.⁶

• Mistake: Not checking the code on your Form 1099-R.

  Instead: If it does not show your exception, file Form 5329 to claim it.¹

Free help and other options

Before you touch your retirement, see whether you qualify for down payment assistance, which some programs do not ask you to repay, or whether your family can give you a documented gift of money. Our guide How much down payment you need shows what each loan type asks for. And remember that your retirement savings are also your safety net: if you use them up, it helps to have an emergency fundemergency fundAn emergency fund is cash you set aside only for unplanned expenses or emergencies, such as car or home repairs, medical bills or a loss of income. It is not for routine monthly spending. The CFPB explains that without savings, even a small financial shock can push you into debt that is hard to pay off. How much you need depends on your situation; the CFPB suggests thinking about the unexpected expenses you have had before. You can keep it in a bank or credit union account, on a prepaid card or in cash, and it grows more easily with automatic saving or part of a tax refund.See the full definitionClose.

For taxes, the IRS’s VITA and TCE programs prepare basic returns for free for people who qualify.¹⁰ Our guide Free tax filing explains how to find a site. For the buying plan, a HUD-approved housing counselorHUD-approved housing counselorA HUD-approved housing counselor works at an agency HUD has approved to provide housing counseling: independent, expert advice customized to your situation about buying a home, renting, a missed mortgage payment, a foreclosure or credit problems. The agencies usually charge little or nothing; many serve in Spanish and offer the homebuyer education course several assistance programs require. They are not lenders or real estate agents and sell you nothing. Your county page lists the official agencies with phone numbers.See the full definitionClose can help you for free or at low cost; search by ZIP code on the CFPB’s website.¹¹

What to do this week

1. Find your most recent statement and write down which kind of account you have and your vested balance.⁷
2. Call your workplace plan and ask for the rules on loans and hardship withdrawals in writing.⁵
3. Check whether you and your spouse meet the rule of 2 years without a main home.³
4. Work out how much reaches you after taxes with the down payment savings plan.³
5. Ask your lender how it will count that money and which papers it needs.⁹