Borrowing From a 401(k) for a Down Payment: What to Weigh

When a home purchase comes together faster than savings, a 401(k) loan can look like a quick answer. Some plans let participants borrow from their own balance, and the money can be used for any purpose, including a down payment. It can be a workable tool for some households, but it carries trade-offs that are easy to overlook in a rush.

Key takeaways

• Some 401(k) plans allow participants to borrow from their own balance, but plans are not required to offer loans.
• The IRS generally limits a plan loan to the lesser of $50,000 or half of the vested balance, with a limited exception for smaller balances.
• A plan loan generally must be repaid within five years in at least quarterly payments, with a longer period possible for a loan used to buy a main home.
• If a loan isn't repaid as required, it is generally treated as a taxable distribution that cannot be rolled over.
• The trade-offs include a new payment alongside a mortgage, money that is no longer invested while it is borrowed, and plan-specific rules about repayment.

How plan loans generally work

The Internal Revenue Service explains the basic rules. Employers are not required to include loans in a 401(k) plan, so the first question is whether yours does. If it does, the IRS says the amount is generally limited to the lesser of $50,000 or half of the participant's vested balance, with a limited exception that lets plans allow a loan of up to $10,000 when half of the vested balance would be lower.

Repayment is also structured. A loan generally must be repaid within five years, in roughly equal payments of principal and interest made at least quarterly. The IRS notes that a loan used to purchase a main home may be repaid over a longer period, subject to the plan's own terms.

What a loan can look like

Consider a hypothetical borrower who takes a $30,000 plan loan at 7 percent, repaid over five years. The payment would be about $594 a month, and the total interest would be roughly $5,640.

Two points matter in that example. The treatment of repayments and interest depends on the plan. The borrowed $30,000 is out of the investments while it is outstanding, and what it might have earned instead could be higher or lower than the loan rate. The comparison is uncertain in both directions, so review your plan documents and ask the plan administrator how payments are handled.

The new payment alongside a mortgage

A plan loan requires scheduled repayments under the plan's terms, and it adds a monthly obligation to the budget on top of the new mortgage, taxes, insurance and maintenance. That can matter more than the loan itself. A household that is stretching to buy may find the additional payment tightens a budget that is already full.

Lenders also review a borrower's overall finances. It is reasonable to ask a mortgage lender how a plan loan, and its payment, would be treated in the application, before borrowing rather than after.

If the loan isn't repaid

The IRS states that a plan loan that is not repaid according to its terms is generally treated as a taxable distribution of the outstanding balance, known as a deemed distribution, and a deemed distribution cannot be rolled over into another retirement plan.

The IRS page does not describe in general what happens to an outstanding loan if the borrower leaves the employer. Plans differ, and it is the kind of detail worth asking about before borrowing, particularly for someone who might change jobs.

Questions to ask before deciding

1. Does my plan allow loans, and are there limits or fees beyond the IRS maximums?
2. Is a longer repayment period available for a home purchase, and what would the payment be?
3. What happens to the loan if I leave the company or stop being able to pay?
4. How would this payment fit into my monthly budget alongside the mortgage and other housing costs?
5. How would a mortgage lender treat the loan when evaluating my application?
6. What would the retirement balance look like in several years if the loan had not been taken?
7. Are there other sources for the down payment that I haven't compared?

Because tax treatment depends on the individual, a conversation with the plan administrator, along with a tax professional, can fill in the details that a general article cannot.

Common questions

Can I borrow from my 401(k) to buy a house?

It depends on your plan. Employers are not required to offer loans, and those that do set their own terms within IRS limits. Your plan administrator can tell you whether loans are available and how a home purchase is treated.

How long do I have to repay a 401(k) loan?

The IRS says a plan loan generally must be repaid within five years in at least quarterly payments, and that a loan used to buy a main home may be allowed a longer period. The exact term is set by the plan.

What happens if I can't repay the loan?

The IRS says a loan in default is generally treated as a taxable distribution of the outstanding balance, and it cannot be rolled over into another retirement plan. Because the tax effects depend on your situation, a tax professional can help.

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