What you can actually do with a 401(k) for a down payment

You have three real options: borrow against your 401(k) through a loan, withdraw money early under a rule called the first-time homebuyer exception, or straightforward leave the money untouched and use other savings. Each one has different costs and consequences, and the one that makes sense depends on your specific plan and your situation.

The first-time homebuyer exception lets you withdraw up to $35,000 from a traditional or Roth 401(k) without the usual 10% early withdrawal penalty if you haven't owned a home in the past two years. A 401(k) loan lets you borrow from your own balance and pay yourself back with interest. Both sound appealing, but both come with tradeoffs that matter more than they first appear.

Key Takeaways

  • The first-time homebuyer exception allows you to withdraw up to $35,000 from a 401(k) without the 10% early withdrawal penalty, but you still owe income tax on the withdrawal.
  • A 401(k) loan lets you borrow against your balance at a rate your plan sets, but if you leave your job, the loan typically must be repaid within 60 days or it becomes a taxable withdrawal.
  • Withdrawing from a 401(k) reduces the money that grows tax-deferred for retirement, which can cost you significantly more than the down payment amount over time.
  • Not all 401(k) plans allow loans or the first-time homebuyer withdrawal, so you must check your plan documents or ask your plan administrator before assuming you can use either option.
  • If your employer matches contributions, withdrawing or borrowing may cause you to lose matching money you would have otherwise received.

The first-time homebuyer exception: how it works and what it costs

If your plan allows it, you can withdraw up to $35,000 from a traditional 401(k) or Roth 401(k) as a first-time homebuyer without paying the 10% early withdrawal penalty. The IRS defines a first-time homebuyer as someone who has not owned a home in the past two years — you do not have to be buying your first home ever.

The catch is that you still owe income tax on the withdrawal. If you withdraw $35,000 from a traditional 401(k), that $35,000 gets added to your income for the year, and you pay tax on it at your normal tax rate. If you withdraw from a Roth 401(k), the withdrawal itself is not taxed, but only if you meet certain conditions — the account must be at least five years old, and you must be 59½, disabled, or dead. Most people using the first-time homebuyer exception from a Roth will owe tax on the earnings portion of the withdrawal.

Beyond the when ready tax bill, there is a larger cost: the money you withdraw stops growing tax-deferred. If you withdraw $35,000 at age 35 and that money would have grown at 7% per year until age 65, you lose roughly $270,000 in growth. That is the real price of using a 401(k) for a down payment.

Taking a loan from your 401(k) instead of withdrawing

A 401(k) loan lets you borrow from your own balance. You pay interest back to yourself, and the loan does not count as income, so there is no when ready tax bill. The interest rate is typically the prime rate plus 1% to 2%, which is often lower than a personal loan or credit card but higher than a mortgage rate.

The major risk is what happens if you leave your job. Most plans require you to repay the full loan balance within 60 days of separation. If you cannot repay it, the unpaid balance becomes a taxable withdrawal, and if you are under 59½, you owe the 10% early withdrawal penalty on top of the income tax. This can turn a $50,000 loan into a $20,000 tax bill very quickly.

A 401(k) loan also reduces the balance that is earning returns for retirement. While you are paying interest back to yourself, that money is not invested and growing. If you borrow $50,000 and take five years to repay it, you lose five years of growth on that $50,000, which compounds over the decades until retirement.

Checking whether your plan allows either option

Not every 401(k) plan allows loans or the first-time homebuyer exception. Some plans prohibit both. Some allow loans but not the exception. Some allow the exception but not loans. You cannot assume your plan offers either one.

To find out, contact your plan administrator — usually the HR or benefits department at your employer, or a benefits company name listed on your 401(k) statements. Ask them directly: "Does my plan allow 401(k) loans?" and "Does my plan allow the first-time homebuyer exception?" Get the answer in writing if possible, because you will need to know the exact rules before you decide.

If your plan does allow loans, ask what the interest rate is, what the repayment term is (usually five years, but it varies), and what happens to the loan if you leave the company. If your plan allows the first-time homebuyer exception, ask whether it applies to traditional 401(k)s, Roth 401(k)s, or both.

How employer matching works when you withdraw or borrow

If your employer matches your contributions — for example, matching 50% of what you contribute up to 6% of your salary — withdrawing or borrowing from your 401(k) can affect that match going forward.

The rules vary by plan. Some plans suspend matching contributions while you have an outstanding loan. Some plans reduce your match if your balance drops below a certain level. Some plans do not change the match at all. Again, this is a question for your plan administrator, because the impact on your take-home pay could be significant.

If your employer matches and you are considering a withdrawal or loan, calculate what you would lose in matching contributions over the repayment period or the year of withdrawal. That cost should factor into whether using your 401(k) makes sense compared to other down payment sources.

Alternatives to using your 401(k)

Before you withdraw or borrow from a 401(k), consider whether other sources of down payment money are available. A down payment does not have to come from your own savings — it can come from a gift from family, a down payment information program run by your city or state, a grant from a nonprofit, or a lower down payment mortgage that requires mortgage insurance instead of a large upfront payment.

Many first-time homebuyer programs offer down payment help with no repayment required. Some are forgivable loans, meaning you owe nothing if you stay in the home for a set period. Some are grants. The terms vary widely by location, but they exist in most states and many cities. A local housing authority or a 211 referral can tell you what programs exist where you live.

A lower down payment with mortgage insurance is also worth calculating. If you put down 5% instead of 20%, you will pay mortgage insurance, but you keep your 401(k) intact and growing. Over 30 years, the cost of mortgage insurance might be less than the cost of losing 30 years of growth on a $35,000 withdrawal.

The tax filing step after a withdrawal or loan

If you do withdraw from your 401(k), your plan will send you a Form 1099-R in January showing the withdrawal amount. If you used the first-time homebuyer exception, you will report the withdrawal on your tax return, and the IRS will calculate the tax you owe based on your total income for the year.

If you took a loan, there is no Form 1099-R unless the loan is forgiven or becomes a taxable distribution. You straightforward repay the loan through payroll deductions, and there is nothing to report on your tax return unless the loan goes into default.

Keep records of what you used the money for — the down payment, closing costs, or other home-purchase expenses. While the first-time homebuyer exception does not require you to prove what you spent the money on, having documentation protects you if the IRS ever asks questions.

Frequently Asked Questions

Can I withdraw from my 401(k) if I am not a first-time homebuyer?

No, the first-time homebuyer exception is the only way to avoid the 10% early withdrawal penalty on a 401(k) withdrawal before age 59½. If you do not meet the first-time homebuyer definition, you can still withdraw, but you will owe both income tax and the 10% penalty on the full amount. A 401(k) loan, if your plan allows it, does not have this restriction.

What happens to my 401(k) loan if I get laid off?

Most plans require you to repay the full loan balance within 60 days of leaving your job. If you cannot repay it, the unpaid amount becomes a taxable withdrawal, and you owe income tax plus a 10% penalty if you are under 59½. Some plans allow you to extend the repayment period, but you must ask your plan administrator about this before you leave.

Can I withdraw from a Roth 401(k) for a down payment without paying tax?

Contributions to a Roth 401(k) can be withdrawn tax-free, but earnings cannot be withdrawn tax-free unless the account is at least five years old and you are 59½, disabled, or dead. Most people using the first-time homebuyer exception from a Roth will owe tax on the earnings portion. Ask your plan administrator to calculate the tax impact before you withdraw.

Does using my 401(k) for a down payment affect my credit score?

A withdrawal does not affect your credit score because it is not a loan. A 401(k) loan also does not appear on your credit report, so it does not directly affect your score. However, both reduce the cash you have available, which can affect your debt-to-income ratio when you explore for a mortgage.

Can I use my spouse's 401(k) for the down payment?

Only if you are married and file taxes jointly. The first-time homebuyer exception and 401(k) loans are individual — you can only use your own 401(k). Your spouse can use their own 401(k) separately, but they cannot access yours, and you cannot access theirs.