3 things to know when financing a home with 401(k) withdrawal

The real estate market in Arizona has been cooling down. In fact, the median home price in Phoenix is currently $410,500. This number is still high and may be difficult for many to afford. For those who want to get into the market, there is an option for them to borrow against their 401(k) funds with no penalties to purchase a primary residence.

While it is not usually recommended to withdraw funds from your 401(k) before retirement, homebuyers can borrow against their 401(k) funds without paying tax penalties when the purpose is for purchasing a primary residence. This type of loan against the 401k must be repaid but does offer a buyer access to the downpayment they may need to purchase a home sooner rather than later.

Those interested in using their 401K to invest in real estate should consider the following before making changes to their 401(k).

Penalties that come with purchasing a home

Individuals with a 401k are encouraged not to withdraw from their plan before the age of 59 ½. Those who choose to withdraw from their 401k early will face a 10% early withdrawal penalty. They also will face an additional income tax on the amount that has been withdrawn. For this reason, a 401k loan for the downpayment may be a better option.

When buyers are purchasing their first home, Rocket Money states their credit score may have a short-term decrease. However, after several months of consistent on-time payments and avoiding significant debt, a homeowner's credit score will receive a boost. In addition, those looking to buy a home should refrain from opening new credit lines or taking out an auto loan. These are considered hard pulls on your credit score and will affect buyers from getting the best mortgage rate.

Other options before withdrawing from your 401K

Before buyers look towards their 401Ks for assistance in buying a house, they should see what loans they qualify for. Active service members, veterans, and family members are eligible for the VA loan, which allows for no down payment or closing costs. Another option for homebuyers is an FHA loan. An FHA loan is a government-backed mortgage that allows for a lower credit score and down payment than other conventional loans. This program can be used with as little as 3.5% down.

For those who do not qualify for these loans, they can look into down payment assistance programs. These types of programs are commonly intended for use by low to moderate income homebuyers and may have income limit restrictions. These programs can be found both locally and at the state level and provide financial assistance to new homeowners.

There may also be options for assistance with closing costs. such as the Homebuyer Assistance Program offered by Minute Mortgage. The Minute Mortgage program can be combined with concessions offered by the sellers to pay for lender closing fees, title fee, prepaids, and a home warranty. This Homebuyers Assistance Program gives up to 1% of the loan amount in credit toward these closing costs, helping reduce the out-of-pocket expenses typically incurred when purchasing a home.

The potential growth in property value can pay back your investment and a healthy profit

If a homeowner waits to sell until the market is up, a 401K real estate investment would have long-term benefits, such as making your investment back and some profit. For example, the average Arizona home value is up 4.3% over the past year. However, an increase in property value is not always guaranteed, so homeowners would have to watch the market and make a strategic decision of when to sell.

Whether buying a house is in a potential homeowner’s near or far future, it is important that they know all of their options. While a 401K withdrawal may help some, it is not for everyone. Proper research into all loan types ensures that buyers find a home that can fit within their financial plans.

Author: Jennifer Folk is the chief operating officer of Minute Mortgage, where she leads operations and sales in their strategic growth efforts, focusing much time on the education aspect of homeownership. Folk’s seasoned background includes more than 20 years of mortgage experience in various roles where both her direct work and her support efforts have helped thousands of homebuyers reach their goals and dreams of homeownership.