Down Payment Via Your 401(k)?

On our Buying or Selling a Home discussion board the other day, a Fool Community member asked a question that's likely on many people's minds:

I'm trying to purchase a home for nearly $380,000. However, I don't have the typical 20% down, or even 10%. So I've heard through the grapevine that I can withdraw from my 401(k), up to 50% of what I have in there, for a no-tax-penalty down payment because I'm a first time home buyer. Is this really true? And is it recommended? If it's not recommended, are there other programs out there that I might be able to take advantage of for purchasing a home without a down payment?

As typically happens, he received a bunch of thoughtful replies from fellow board denizens. Here are a few highlights:

Linanil said:

I wouldn't recommend it because I've known people who have done it. Withdrawing from your 401(k) is risky. If you lose your job, the money is immediately due . I've thought of borrowing against my 401(k) before to pay off my credit cards, but I didn't because I knew that I will need my retirement money for, well, retirement. Is it possible for you to save 3% down? If not, can you really afford the place you are trying to buy? There are 0% down programs but you end up paying a lot for them.

Aj485 added:

I think your grapevine is mixing issues here:

1) Withdrawal from an IRA for a first-time homebuyer . A first-time homebuyer may withdraw up to $10,000 from an IRA (not a 401(k)) without having to pay the 10% early distribution penalty. They still must pay the taxes.

2) Loan from a 401(k) ... Depending on the rules of your 401(k) plan, you may borrow up to $50,000 or 50% of your vested balance, whichever is lower, from your 401(k) to purchase a home..

There are usually ways to finance with no money down without having to borrow from your 401(k) -- there are a lot of different strings attached to 401(k) loans, like the possibility of having to repay it within one to six months if you change jobs. Plus, most 401(k) loans have rates of something like prime plus 1% -- you can probably get a loan for the home for the same price, or less, and it's deductible.

Donna405 offered:

Do you live in Northern Virginia or Maryland? If so, you might want to check on how the housing prices are dipping rather markedly. I would wait at least a year before taking the plunge. Save as much as you can in the next year, continue renting. Hopefully, within the year, you will have a fairly good down payment. How much do you have saved now? Remember, [there's] PMI [private mortgage insurance] if you have less than 20% down.

TMFPMarti added:

As has been noted, you can't withdraw [as opposed to borrowing] from your 401(k) while you're employed by the sponsor, except for hardship. Hardship withdrawals cannot be rolled into an IRA, and there's no penalty exception for 401(k) withdrawals used for home purchase. Even when they come from an IRA the lifetime limit is $10,000 penalty-free.

Aside from all that, let's assume for the sake of discussion that you could tap your 401(k) for this purpose. How would you pay the income tax that would be due on the distribution? That would likely take a sizeable chunk out of what you intended for your down payment.

A better approach would be to explore the various ways you can structure a purchase with a small down payment. There's at least one mortgage pro on the board who should be able to give you some tips. You might also want to check prior threads, where there's been a lot of discussion.

There were plenty of other people offering good advice (read it all), but the bottom line for this would-be homebuyer is this: If you must borrow, find the best terms you can. There may well be a better option than raiding a 401(k) account, which has some downsides and would compromise your retirement. You must also consider not borrowing now. Instead, this might be a good time to accumulate savings for a down payment.

Get guidance on how to sock money away for the short term (such moolah should not be in stocks!) in our Savings Center.

If you're interested in homebuying and -selling issues, visit our Home Center, which features lots of money-saving tips and some special mortgage rates.

If you're thinking about buying real estate as an investment, consider an alternative that you can get into and out of much more easily: real-estate-focused mutual funds. The CGM Realty Fund (FUND: CGMRX  ) , for example, has grown at an annual average clip of 35% over the past five years, enough to turn $10,000 into more than $44,000. Its current top holdings include AvalonBay (NYSE: AVB  ) , Jones Lang LaSalle (NYSE: JLL  ) , and Phelps Dodge (NYSE: PD  ) . (A quick disclaimer: Fools should bear in mind that past performance doesn't necessarily predict future gains. As always, do your due diligence before you invest!)

You might also want to check out these articles:

To see what real estate fundMotley Fool Champion Fundshas recommended in the past, try our fund-focused investment newsletter service free for 30 days.

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. The Motley Fool has a full disclosure policy.

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Selena Maranjian

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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