Using a 401(k) loan to buy a house

What makes a home-purchase loan different

IRC 72(p)(2)(B)(ii) exempts a plan loan from the 5-year limit when it’s “used to acquire any dwelling unit which within a reasonable time is to be used… as the principal residence of the participant.” The IRS regulations add three details:

• The loan doesn’t have to be secured by the house.
• It has to be for your main home, using the same definition as the home-sale exclusion.
• Refinancing a mortgage you already have generally doesn’t qualify.

The borrowing limit doesn’t change: still the lesser of $50,000 or half your vested balance. Only the term can stretch, and only if your plan offers a longer residential term. Ask for the plan’s loan policy; it will say whether a residential loan is offered and for how long.

What a longer term does to the numbers

A longer term lowers the payment and raises the growth you give up, because the money stays out of your investments longer. Borrowing $30,000 at 8%, paid every two weeks:

Term	Payment per paycheck	Total interest
5 years	$280	$6,444
10 years	$168	$13,627
15 years	$132	$21,557

All of that interest goes back into your account, but the longer the loan runs, the longer it is exposed to a job change. A 15-year loan is a bet that you’ll stay at this employer, or have the cash to pay it off, for 15 years.

How mortgage lenders treat it

Fannie Mae’s Selling Guide covers both sides of the application:

• As a source of cash. Funds borrowed against a 401(k) are “an acceptable source of funds for the down payment, closing costs, and reserves” (section B3-4.3-15). The lender will want the loan terms and proof the money came from the plan.
• In your debt-to-income ratio. A loan secured by your own retirement account is a contingent liability that the lender “is not required to include” in your monthly debts, as long as the loan document is in the file (section B3-6-05).
• In your reserves. If your 401(k) counts toward reserves, the lender subtracts what you borrowed from the balance it counts.

That treatment is Fannie Mae’s. FHA, VA and portfolio lenders write their own rules, so ask your loan officer how the payment will be counted before you take the loan.

Loan vs. withdrawal for a down payment

	401(k) loan	401(k) withdrawal
Tax	None if repaid	Income tax on the full amount
10% additional tax	No	Yes, if under 59½
First-time homebuyer exception	n/a	Doesn’t apply to 401(k) plans
Counted in mortgage DTI (Fannie Mae)	Not required	No payment to count
Effect on your account	Restored as you repay	Permanent
If you leave your job	Balance due; offset if unpaid	None

A home purchase is one of the IRS safe-harbor reasons for a hardship withdrawal, so your plan may allow one. You’ll still owe the tax and, under 59½, the 10%. On $20,000 in the 22% bracket that’s $6,400 gone before state tax, against $0 for a loan you repay.

A few questions to settle first

1. Does my plan offer a residential loan, and for how long?
2. Will my lender count the payment in my DTI under the program I’m using?
3. If I change jobs in the next few years, where would the payoff money come from?
4. Will I keep contributing enough to get the full match while I repay?

If the answer to number 3 is “nowhere,” compare the loan against a smaller down payment with mortgage insurance. That’s a question for your loan officer, with real quotes.