In the midst of the coronavirus crisis, many people lost their jobs or saw their business revenue drop dramatically. At the same time, mortgage rates plummeted to historical records, making this a good time to buy a home. But if you are short on money, how to deal with the down payment? And this situation also applies for first-time home buyers. Many people are considering using 401(k) to buy their home. Would that be a good idea? Maybe not. Read on to find out why.
First, let’s take a look at some 401(k) rules!
The main reason that might not be the best move now, is because there is an opportunity cost hidden in the strategy.
401 accounts are financial instruments designed to guarantee the retirement of those who have hired this type of plan. For this reason, the government grants tax incentives to anyone who hires a 401. Tax deduction comes with a responsibility. The government expects you to keep the money invested in the fund for a long time. For this reason, the government imposes rules, restrictions and limits on those who want to withdraw money ahead of time.
For example, if you are under 59, are employed and decide to withdraw money from the fund, you will have to pay a 10% penalty. In addition, you will have to pay income tax on the amount drawn.
In order not to incur penalties or taxes, one solution would be to borrow from the fund. How does it work?
Applying for a 401 (k) loan is the most recommended option, as you will not incur in penalties and you will not need to pay income tax either.
You have to pay interest, too (prime rate plus one or two percentage points). In the period when you are paying the loan back to the account, the fund will probably not let you make new contributions.
The loan installments do not count as a contribution. Then you will have no tax deduction on them.