Why It’s Risky To Use 401k Loans For Down Payments

Most companies allow employees to borrower up to 50% of their 401k balances, to be paid back within five years while remaining at the company....​

However, the loan typically becomes due within 60 days of a worker’s employment termination. So if you get laid off, your company closes its doors, or you decide to switch jobs for a better opportunity elsewhere, you’ll have to pay back the full loan amount within a couple months.

If you don’t pay off your loan within 60 days, it’s treated as an early withdrawal for tax purposes. This means you’re taxed on that money by the IRS & State as ordinary income. Plus you’ll pay a 10% IRS penalty (and State penalty = 2.5% in CA).

For Example:
If you have a 401k loan balance of $20,000 and your marginal tax bracket is 25% (IRS) and 9.3% (CA), you would owe $5,000 to the IRS and $1,860 to CA. Plus, you’d owe an additional penalty tax of $2,000 to the IRS and $500 to CA.

That’s a grand total of $9,360 in taxes, a hefty amount on that $20,000 loan!

As you can see, this is a substantial penalty if you aren’t able to pay back the loan. Therefore, we rarely suggest borrowing from your 401k for a home down payment.

Generally we only advocate it as an option if you have the savings to support paying back that money at any time, but you just don’t want to use savings for the down payment.

Even then, there are still downfalls. While your money is taken out on loan or withdrawn, it is no longer achieving  market gains and it means you’re stopping future contributions for an indefinite period of time...all things that are not great news!

As is always the case, everybody has unique circumstances. Feel free to contact us if you’d like to discuss your specific situation...we’re here to help!