Can a First-Time Home Buyer Use Their 401(k) or IRA for a Down Payment?

Securing a down payment can be difficult for first-time home buyers. They often hold debt from credit cards, student loans, or car loans that eat up disposable income. And first-time homebuyers don’t have the benefit of selling a home that’s appreciated and using the proceeds as a down payment. For many, taking money out of a 401(k) could provide the large sum needed for a house down payment.

Of course, using your 401(k) for a down payment comes with costs and risks. A financial professional can help determine if this strategy is wise for your unique situation. We’ll outline the pros and cons of a 401(k) withdrawal for first-time home buyers and offer alternative sources for a down payment.

How much do you really need for a down payment?

The down payment you need will depend on the home’s total cost and the type of loan you have. Experts generally recommend saving at least 20% of the home cost, which lets you avoid paying private mortgage insurance (PMI). Conventional loans usually require paying PMI — which can be anywhere from .2–2% of the original loan amount per year—until you reach 20% home equity.

However, a 20% down payment isn’t required for all mortgages. The National Association of Realtors® said first-time home buyers put an average of 8% down in 2023.[1] With the typical starter home costing about $196,611, an 8% down payment would be around $15,728.[2]

Veterans Affairs (VA) and Federal Housing Administration (FHA) loans only require down payments of 3.5% or less, although they have stricter qualification requirements than conventional mortgage loans.

Using a 401(k) for a down payment

First-time home buyers can withdraw funds from their 401(k) to secure a down payment quickly. Borrowers only have access to the vested amount in their account — not the ending balance, as company matching funds may not be immediately available.

There are a few options for withdrawing 401(k) funds. However, accessing these accounts before retirement age may incur penalties and fees. And you’ll lose out on all the gains you would’ve gotten if you’d left the funds in there, which can be significant.

401(k) loan for first-time home buyers

A 401(k) loan lets buyers borrow whichever of these options is less:

• 50% of the vested 401(k) balance
• Up to $50,000

Home buyers with more than one 401(k) can combine these options. We recommend talking with a financial professional to make the best decision for you.

Repayments must typically be made within five years and often come directly from the employee’s paycheck.

Hardship distribution for first-time home buyers

A hardship distribution can be made to satisfy an immediate and heavy financial need, like a down payment. It is limited to the amount of that financial need.

Hardship distributions are subject to income taxes and may incur a 10% tax on early distributions. These funds cannot be repaid to the plan or rolled over to another plan.

Pros of using a 401(k) withdrawal for a down payment

There are some clear benefits to borrowing from your retirement fund. For instance:

• No loan application is needed.
• There’s no credit score requirement.
• Automatic paycheck deductions make repayment fast and easy.
• Funds are generally available within 10 business days.

Cons of using your 401(k) for a down payment

While borrowing from your 401(k) may seem like a good option, there are some risks involved:

• You must pay interest on the amount withdrawn if it’s not a hardship distribution. If it’s a hardship distribution, it will count as taxable income and may include a 10% early withdrawal penalty.
• The entire 401k loan amount is due (or eligible for full taxes) if you leave your employer before you’ve repaid the loan.
• If you can’t repay the loan, you’ll owe taxes and a 10% penalty on the outstanding balance.
• Pulling from your retirement account can impact your financial health in the future.

This last drawback is a critical point to consider. Due to inflation and a higher overall cost of living, experts recommend saving $572,000 for a comfortable retirement. Most Americans have nowhere close to that set aside, making money in your 401(k) extremely valuable. If you borrow from it today, you could lose money down the road.

A financial advisor or a 401(k) loan calculator can help estimate your losses. Say you want to borrow $15,000 from your 401(k). You plan to repay it at a 7% interest rate over five years. Meanwhile, your 401(k) will grow at a 10% rate of return, and you’ll retire in 30 years.

Even if the loan is repaid on time, your 401(k) will lose about $12,500. If you fail to repay the loan, additional taxes plus the 10% penalty bring your loss to more than $353,000.

Down payment alternatives for first-time home buyers

Using a 401(k) as a source for a down payment can be an appealing option for first-time home buyers. However, your retirement savings will take a hit, and you’ll lose significantly more money if you can’t repay the loan or leave your job.

We recommend exploring other first-time home buyer options before withdrawing from your 401(k).

IRA withdrawals

First-time home buyers can withdraw $10,000 from their IRA without penalty. There’s no need to show a hardship. Income tax still applies as well as the long-term financial losses you’ll incur.

Low down payment loans

Look for a loan that requires a lower down payment. Popular options include the following:

• FHA loans: These federal loans require a 3.5% down payment for those with a 580+ credit score. You’ll have to pay mortgage insurance premiums (roughly 0.55% of the total mortgage amount) and closing costs, but there’s no penalty for repaying the loan early.[3]
• USDA loans: The U.S. Department of Agriculture offers loans for first-time home buyers willing to move to rural areas. These loans are very low-interest and often go to lower-income buyers, so they rarely require a down payment.
• VA loans: These loans are available to those who have served in the U.S. military (or their surviving spouse). They boast lower interest rates and often no down payment. However, you must pay a VA Funding Fee, ranging from 1.25% to 2.15% of the loan amount.

Home buying grants and programs

You might also consider a home-buying grant or program that prioritizes funding for first-time home buyers. 

• Fannie Mae’s HomePath Program provides up to 3% closing cost assistance to first-time home buyers who purchase HomePath properties — foreclosed homes owned by Fannie Mae.
• The National Homebuyers Fund DPA Program offers up to 5% of the mortgage loan amount to cover a down payment or closing costs.
• The USDA’s Rural Development Loans help low- to moderate-income households buy a home in an eligible rural area by providing a 90% loan note guarantee to approved lenders.

In addition, HUD’s Revitalization Areas program offers discounted home sales in two ways. The Asset Control Area (ACA) program provides steep discounts on certain foreclosed properties. The Good Neighbor Next Door (GNND) program lets teachers, law enforcement officers, firefighters, and EMTs purchase homes in a revitalization area for 50% of the listing price.

Get expert advice before using your 401(k)

First-time home buyers often have many questions about buying a home, with the down payment topping the list. Coming up with the required amount of cash can be especially difficult for those early in their careers and holding other debts.

Borrowing a down payment from your 401(k) may be an attractive option, but you must also consider the risks. Talk with a financial professional to better understand how a withdrawal today can impact your retirement future.

A top-rated real estate agent can also walk you through your financing options and help you find lenders requiring small or no down payments. Get matched with an experienced agent near you.