One in 10 homebuyers tap retirement accounts to help come up with their down payments, according to a recent survey — and financial planners say that’s not necessarily a bad thing.
A recent Bankrate survey found that 9% of recent homebuyers used funds from their retirement account toward their down payment. While financial planners agree that is not the ideal first place to go to help fund a down payment, it is not necessarily a bad place to go — as long as it is a loan and not a withdrawal.
For potential buyers who feel strongly about homeownership or feel they are wasting money on rent, forgoing some short-term retirement account returns on the money borrowed may make sense.
The IRS sets guardrails that protect retirement account holders from dipping dangerously far into their retirement savings for a loan. The loan must be taken from a current retirement account that the holder is actively contributing to, and leave most of the balance preserved.
“There are limits on the amounts you can borrow,” said Bankrate analyst Jeff Ostrowski. “It is $50,000 or 50% of the balance of the 401(k) and then it is up to a five year repayment plan.”
Loan rates from retirement accounts such as a 401(k) are generally set to the prevailing prime rate plus 1% to 2%, making the terms of the loan competitive to other forms of borrowing.
While a loan avoids penalties triggered by withdrawals for those under 59-and-a-half years old, the amount of the loan is deducted from the retirement account’s balance, and is slowly regained as payments are made. That means the amount of money borrowed from a retirement account is no longer growing.
“For the time that money is out of the market, you are not getting a return,” Ostrowski said. “In general, if the markets go up by 8% or 9% a year, you are forgoing those returns for the time that your money is out of the market.”
Also, retirement plan loans do not allow the borrower to deduct interest paid, as is the case with mortgage interest.
The survey found that younger borrowers are much more likely to use a retirement account loan for all or part of their down payment, with 16% of Gen Z-ers and 12% of millennials saying they did so. That can reduce the long-term blow to a retirement account’s earning power.
“Borrowing $40,000 or $50,000 from your 401(k) at age 30 shouldn’t be a huge impediment to your financial success in 30 or 40 years,” Ostrowski said.
For buyers who haven’t saved enough for a down payment, considering other options before a retirement account loan is ideal, Ostrowski said. While 41% of the recent homeowners surveyed by Bankrate said they managed to save the money for the down payment and closing costs, 14% relied on a family gift, and another 14% took advantage of a first-time homebuyer or loan assistance program.
While the retirement account loan is an easy process, it should be considered carefully — another recent survey found that Americans’ top financial regret was not beginning to save for retirement earlier.
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