Loan from 401K to purchase house?

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uberme
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Loan from 401K to purchase house?

Post by uberme »

We're looking to upsize and plan to put a sizable amount down (greater than 20%). Been quoted for a 30 year 5.87%. Also considering rolling gains from existing house (will move then sell) into the loan but want to see if rates fall within one year of purchase.

My 401K allows the option of taking a max $50,000 loan with interest rate of 8.75% (total repayment of $90,000 after-tax payroll deductions). Since I'm paying myself back the interest why wouldn't I do this? Total fees are $500, can go up to 180 months (two payments per). Is the thinking the market could return more than that? Our AA is 75/25.

Thanks!
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David Jay
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Re: Loan from 401K to purchase house?

Post by David Jay »

Be aware that if you lose your job or leave the company, the entire loan must be repaid or it will be treated as an unqualified distribution (assuming one is younger than 59.5). You will owe regular income taxes on the outstanding amount plus a 10% penalty.

If you are over age 59.5 you will still owe taxes on the outstanding amount at regular income tax rates.
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20cm
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Re: Loan from 401K to purchase house?

Post by 20cm »

uberme wrote: Sat Mar 25, 2023 10:13 am Is the thinking the market could return more than that?
Return more than what? The 8.75% loan interest you are adding into the 401k via repayments is not a return, it's your own money. Not only is it your own money, it's after tax money and it's not tax deductible the way mortgage interest is. You will be taxed on that interest portion of the loan repayment (plus its subsequent growth) again when you take distributions from your 401k in retirement, so that interest portion is taxed twice. You will need to do the math at your tax rate/situation to see what market return would make it a break-even proposition.

The main risk is that the market goes up and you have that money out of the market. On the other hand, the market could go down and you could avoid riding it down. I got lucky like that with a 401k loan in early 2002 and my repayments went in on average about 12-15% lower than what I took the money out at.
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Brianmcg321
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Re: Loan from 401K to purchase house?

Post by Brianmcg321 »

Terrible idea. Don’t touch your retirement money unless your retired.
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TropikThunder
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Re: Loan from 401K to purchase house?

Post by TropikThunder »

David Jay wrote: Sat Mar 25, 2023 10:21 am Be aware that if you lose your job or leave the company, the entire loan must be repaid or it will be treated as an unqualified distribution
I left my employer over a year ago and I’m still making payments under the original terms.
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David Jay
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Re: Loan from 401K to purchase house?

Post by David Jay »

TropikThunder wrote: Sat Mar 25, 2023 3:46 pm
David Jay wrote: Sat Mar 25, 2023 10:21 am Be aware that if you lose your job or leave the company, the entire loan must be repaid or it will be treated as an unqualified distribution
I left my employer over a year ago and I’m still making payments under the original terms.
OK, "must" was too strong, but it is true in many cases.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
placeholder
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Re: Loan from 401K to purchase house?

Post by placeholder »

David Jay wrote: Sat Mar 25, 2023 10:21 am Be aware that if you lose your job or leave the company, the entire loan must be repaid or it will be treated as an unqualified distribution (assuming one is younger than 59.5). You will owe regular income taxes on the outstanding amount plus a 10% penalty.
The rules changed dramatically a few years back and the employee can roll over the plan assets minus the loan amount to an ira or other retirement plan with the difference designated an offset and then have until tax filing due date with extensions for the tax year in which the offset occurs to make up the difference and avoid tax and penalty.
livesoft
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Re: Loan from 401K to purchase house?

Post by livesoft »

Years ago my spouse took out a $50,000 401(k) loan. Not to buy a house, but to avoid the almost 2% expense ratio of the lowest e.r. fund that the 401(k) was invested in. 2% of $50K a year is $1,000 a year. The money was used to buy a substantially identical investment in 529 plans with an expense ratio under 0.05%, thus any increase in the 529 plans could (and was) eventually withdrawn tax-free.

All was well and good until her company was sold. She did not lose her job, but continued under the new owners. However, the 401(k) plan was shut down and folded into the new buyer's existing 401(k) plan. Her 401(k) loan came due in 30 (or 60?) days. My spouse just paid back the loan using money in our taxable account.

She learned that a colleague had taken out a $50K loan to build a house and didn't have money to pay back their loan. As you can surmise their loan became a withdrawal, was taxed as income, and had a 10% penalty applied as well.
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Re: Loan from 401K to purchase house?

Post by placeholder »

livesoft wrote: Sun Mar 26, 2023 2:27 am All was well and good until her company was sold. She did not lose her job, but continued under the new owners. However, the 401(k) plan was shut down and folded into the new buyer's existing 401(k) plan. Her 401(k) loan came due in 30 (or 60?) days. My spouse just paid back the loan using money in our taxable account.
As I noted above the law changed and experiences from years ago are probably not relevant as the time to pay back is greatly increased these days.
260chrisb
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Re: Loan from 401K to purchase house?

Post by 260chrisb »

uberme wrote: Sat Mar 25, 2023 10:13 am We're looking to upsize and plan to put a sizable amount down (greater than 20%). Been quoted for a 30 year 5.87%. Also considering rolling gains from existing house (will move then sell) into the loan but want to see if rates fall within one year of purchase.

My 401K allows the option of taking a max $50,000 loan with interest rate of 8.75% (total repayment of $90,000 after-tax payroll deductions). Since I'm paying myself back the interest why wouldn't I do this? Total fees are $500, can go up to 180 months (two payments per). Is the thinking the market could return more than that? Our AA is 75/25.

Thanks!
Really bad idea IMO. Your 401K is a retirement account and should be used as such. If you're going to put down more than 20% my guess is that 50K won't make or break your decision. Also, why not a 15 year fixed rate mortgage?
wetgear
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Re: Loan from 401K to purchase house?

Post by wetgear »

uberme wrote: Sat Mar 25, 2023 10:13 am We're looking to upsize and plan to put a sizable amount down (greater than 20%). Been quoted for a 30 year 5.87%. Also considering rolling gains from existing house (will move then sell) into the loan but want to see if rates fall within one year of purchase.

My 401K allows the option of taking a max $50,000 loan with interest rate of 8.75% (total repayment of $90,000 after-tax payroll deductions). Since I'm paying myself back the interest why wouldn't I do this? Total fees are $500, can go up to 180 months (two payments per). Is the thinking the market could return more than that? Our AA is 75/25.

Thanks!
I’d say doing this should be hard no.
Oddball
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Re: Loan from 401K to purchase house?

Post by Oddball »

I have no problems using a 401k loan to buy a house, but as others have pointed out you do seem to be looking at the interest the wrong way since you will end up being taxed on the interest payments twice. I wouldn't take out any more than you need to get to 20% down and avoid PMI/higher rates, and then pay the loan back once you sell your current house.
placeholder
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Re: Loan from 401K to purchase house?

Post by placeholder »

Oddball wrote: Sun Mar 26, 2023 6:17 pm I have no problems using a 401k loan to buy a house, but as others have pointed out you do seem to be looking at the interest the wrong way since you will end up being taxed on the interest payments twice. I wouldn't take out any more than you need to get to 20% down and avoid PMI/higher rates, and then pay the loan back once you sell your current house.
This source disagrees:

http://www.401khelpcenter.com/faq/faq_2 ... CD9SvbMLVs
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whodidntante
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Re: Loan from 401K to purchase house?

Post by whodidntante »

I think it's fine to take a 401k loan to purchase a house, assuming you are going to buy the house anyway and this is strictly a financing and tax move.
Mikosan
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Re: Loan from 401K to purchase house?

Post by Mikosan »

Please, dear lord, don't do this. The penalties. The fees. Borrowing from your future... Bad on all fronts.
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Re: Loan from 401K to purchase house?

Post by placeholder »

Mikosan wrote: Mon Mar 27, 2023 12:00 am Please, dear lord, don't do this. The penalties. The fees. Borrowing from your future... Bad on all fronts.
What penalties?
Atlantic_ave
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Re: Loan from 401K to purchase house?

Post by Atlantic_ave »

People seem to be pitching in with no idea how a 401k loan works. There are no penalty or double taxation. Only drawback is to be out of the market. It can make aense in many cases, especially in a elevated rates environment.
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Re: Loan from 401K to purchase house?

Post by grabiner »

Atlantic_ave wrote: Mon Mar 27, 2023 3:57 am People seem to be pitching in with no idea how a 401k loan works. There are no penalty or double taxation. Only drawback is to be out of the market. It can make aense in many cases, especially in a elevated rates environment.
And you don't have to be out of the market. You can take the 401(k) loan with money that was in a bond fund. (If your loan is disbursed proportionally, you can reallocate after taking it out.) You keep the same number of dollars in stock.

However, if your employer does not allow you to contribute to the 401(k) while you have an outstanding loan, this can cost you; you may lose the employer match.
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hand
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Re: Loan from 401K to purchase house?

Post by hand »

Assuming you understand the fine print / worst case about forced repayment, to me the question is really about where your retirement savings are above or below where they should be.

If you've been prioritizing taking advantage of every retirement savings opportunity and have benefited from the last 10 years of favorable returns, you may well be ahead of the game. I like to think of this state as 401(k) poor (like house poor, but with retirement assets) In that case, a 401(k) loan may well be a reasonable funding strategy.

If your retirement savings are behind, giving up market returns for consumption (even if it is a house) is likely a bad move.
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uberme
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Re: Loan from 401K to purchase house?

Post by uberme »

Thank everyone for your feedback! Very much appreciated. Still undecided but seems instead of paying the bank near 6% we'd be paying ourselves 8.75%.
Oddball
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Re: Loan from 401K to purchase house?

Post by Oddball »

placeholder wrote: Sun Mar 26, 2023 9:20 pm
Oddball wrote: Sun Mar 26, 2023 6:17 pm I have no problems using a 401k loan to buy a house, but as others have pointed out you do seem to be looking at the interest the wrong way since you will end up being taxed on the interest payments twice. I wouldn't take out any more than you need to get to 20% down and avoid PMI/higher rates, and then pay the loan back once you sell your current house.
This source disagrees:

http://www.401khelpcenter.com/faq/faq_2 ... CD9SvbMLVs
No, it doesn't. I said the interest payments are taxed twice, which they are. The loan balance is not taxed twice, it is not taxed at all as part of the loan.

I have a 401k loan, which I used to buy my house. $50k, 4.25%, 5.5 year term. If I don't pay it back early, the end result will be $50k back into the account which would have basically 0 affect for tax purposes + ~$6,100 "interest" paid by me to me with after tax money. That $6100 was taxed going in and will be taxed again going out.
Last edited by Oddball on Mon Mar 27, 2023 11:36 am, edited 1 time in total.
exodusNH
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Re: Loan from 401K to purchase house?

Post by exodusNH »

placeholder wrote: Sun Mar 26, 2023 9:20 pm
Oddball wrote: Sun Mar 26, 2023 6:17 pm I have no problems using a 401k loan to buy a house, but as others have pointed out you do seem to be looking at the interest the wrong way since you will end up being taxed on the interest payments twice. I wouldn't take out any more than you need to get to 20% down and avoid PMI/higher rates, and then pay the loan back once you sell your current house.
This source disagrees:

http://www.401khelpcenter.com/faq/faq_2 ... CD9SvbMLVs
The interest payments, which are from after-tax income go into the 401k. When those interest payments come out, you pay income tax on them since the "already-taxed" status is lost. From your perspective, you're paying income tax twice on that slug of money.

The gains on securities purchased with the interest are taxed, but that's not double taxed since you never paid tax on the gains.

The same thing happens with a bank loan. When you pay interest, the bank claims that as income. You paid the bank with after-tax money but they pay tax on that income. (This is one of the arguments for taxing home owners on imputed rent payments.)

With a 401k loan, you are both the borrower and the bank.
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Re: Loan from 401K to purchase house?

Post by placeholder »

Atlantic_ave wrote: Mon Mar 27, 2023 3:57 am People seem to be pitching in with no idea how a 401k loan works. There are no penalty or double taxation. Only drawback is to be out of the market. It can make aense in many cases, especially in a elevated rates environment.
I am really surprised at how many don't seem to know about the changes in the laws regarding when the borrower leaves the company as that was big news at the time.
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uberme
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Re: Loan from 401K to purchase house?

Post by uberme »

We got the house! Yoohooo! We decided to skip the 401K loan to keep things simple. Thank you everyone!!
CC Mike
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Re: Loan from 401K to purchase house?

Post by CC Mike »

I suggest that you read the specifics of your 401k plan. Upon reading the details of mine several years ago, I believe the interest that I was going to be paying was not going to go to my account but was to the general fund and was considered a return in the cash general fund for all holders of the cash fund. So I was not adding to my account with the additional interest.
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hand
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Re: Loan from 401K to purchase house?

Post by hand »

CC Mike wrote: Thu Apr 20, 2023 1:29 pm I suggest that you read the specifics of your 401k plan. Upon reading the details of mine several years ago, I believe the interest that I was going to be paying was not going to go to my account but was to the general fund and was considered a return in the cash general fund for all holders of the cash fund. So I was not adding to my account with the additional interest.
Whoa! Thanks for sharing!
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Re: Loan from 401K to purchase house?

Post by placeholder »

CC Mike wrote: Thu Apr 20, 2023 1:29 pm I suggest that you read the specifics of your 401k plan. Upon reading the details of mine several years ago, I believe the interest that I was going to be paying was not going to go to my account but was to the general fund and was considered a return in the cash general fund for all holders of the cash fund. So I was not adding to my account with the additional interest.
I think it likely you misunderstood things so it would be useful for you to post the exact language.
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Re: Loan from 401K to purchase house?

Post by Outer Marker »

uberme wrote: Thu Apr 20, 2023 1:09 pm We got the house! Yoohooo! We decided to skip the 401K loan to keep things simple. Thank you everyone!!
Congratulations and good choice. I would also implement your notion of paying down the loan with the proceeds from your old house. There's no better guaranteed 100% safe return than paying down your new 5.87% mortgage.
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