Disclaimer: Listen, it wouldn’t be prudent for us to start this article without a HEAVY warning. Using your 401K or IRA for the down payment of your house is not a circumstance that should be frequently used or considered. Doing this could benefit a very niche group of people in specific circumstances (that you must decide for yourself), but for the large majority of people, please look at your existing finances first before contemplating this as an option; the costs are high, as well as the risk. Phew, now with that out of the way, let’s get started.

So you want to tap into your “untouchable” money. 

We’re going to give you a couple rules to follow before you can answer this question for yourself. But first, a cookie metaphor: your retirement money is like a cookie. Hear me out, I promise. Now, cookies have a specific set of ingredients–in this case, the only ingredient is your cold, hard, tax-free cash. It must be baked for the proper duration (until you’re 60ish), at just the right temperature (hello 401k matching!), and you should ideally not open the oven while it cooks, or the cookies could fall flat. AND THIS IS WHAT YOU’RE TRYING TO DO RIGHT NOW. I want that to be clear. You are trying to eat your cookies before they are cookies. You could get salmonella, or end up eating a wet, goopy, dough-y mess. 

The #1 problem for taking money out of your retirement accounts, is even if you take out the “dough” prematurely, you are often required to put it back into the account. Repayment options vary, but expect interest, and you will have to pay it out of your already taxed income.

Does it matter which I withdraw from?

The primary difference between 401ks and IRAs is who sponsors it. A 401k is employer sponsored, and an IRA bank/broker sponsored. With two separate entities controlling the accounts, they obviously have different rules for withdrawal of any funds prematurely. These are going to differ for every single person and for every situation, so we want to provide some general guidelines.

Rule #1: Please don’t touch it. I’m serious! This money is for you, when you’re ancient and decrepit and can’t work and you don’t have anyone who will let you ride on their coattails. This is a safety plan for your geriatric self, try to respect that and find money another way. 

Rule #2: If you must take out some money, make it small, and start with your IRA’s. These can be specially equipped to assist first-time home buyers, so long as your withdrawal amount stays below $10k, it can be withdrawn tax-free and without penalty, (though it does get reported to your federal and state taxes as income and could bump you up in a tax bracket which might bite you later). If we’re being honest, in today’s economy, $10,000 is scarce enough for your 3% down payment, so it would only be beneficial if it’s in addition to existing savings that you have prepared for your down payment that would eliminate the need for a jumbo mortgage or PMI–both of which still may be better alternatives depending on the total payments.

Remember: Your retirement accounts are meant to sit untouched and grow with interest. This is how they produce the best options for you. Taking from them prematurely is robbing future you, to pay current you. “Current” you needs to have a bit more sympathy for old, gray-haired, feeble you. 

Rule #3: Try a loan from your 401k, before just a straight-up withdrawal. Your employer will have different rules, but you can take a loan from your “future” self, specifically for your primary residence and can sometimes waive any upfront fees or taxes with the only stipulation being repayment. 

Tip: If you can repay this quickly, but need a quick influx of cash, this may be the right choice for you, depending on your loan length and interest required.

Rule #4: If you must take a withdrawal from your 401k, be prepared for fees and taxes and repayment options that are not friendly. Again, you must check with your employer and see if this is even allowed, and read the fine print to know what the rules for withdrawal are. Can you still contribute to your account with a withdrawal pending repayment? If you cannot, this is a very risky play that could set you back several years in growth for your retirement accounts. 

Why do you want to take out money?

If you’re thinking of using it because you’re short on cash for earnest money, escrow, or at the closing, there are better alternatives. 

Your earnest money can come from any financial source you have and isn’t tracked like down payment income. So you could borrow from a friend, use your credit card as a cash advance (Please also don’t do this), or take out a personal loan. All of these are more preferable. 

Money for escrow typically has to come the same way as a down payment, it’s monitored very closely because the bank needs to ensure that your finances are stable. Withdrawing from your retirement accounts prematurely is still a loan (in some cases), and must be repaid, which adds to your total debt which is the primary contributor to mortgage lenders qualifying you for a loan. It could also jeopardize your loan approval. Truthfully, most banks will wrap closing costs into the life of the loan. 

Also, as much as mortgage insurance sucks, PMI is preferable to having to pay interest and a withdrawal fee and repay yourself (but this time with already taxed income) and all the other shenanigans that we listed above in order to tap into your retirement accounts. If you can, leave those alone to grow for you quietly, and only tap in when necessary. 

Key Questions to ask yourself before using your retirement accounts

How soon will you be able to repay? 

What are your repayment interest rates?

Do you qualify for first time home buyer benefits?

Will your house appraise at a higher rate than your fees and interest for repayment? (This is always going to be a gamble, but you can track annual growth and get a good idea.)

Can you still contribute to your 401k while repaying the amount you’ve already withdrawn? (This of course will impact your 401k future growth.)

Your current tax bracket will likely be higher now, than in the future when you withdraw so you’re losing more money than by letting it grow due to repayment.

A pre-approval from a mortgage lender helps you plan for your maximum house budget. It’s a soft inquiry on your credit, and isn’t tied to a specific house. The amount you get approved for is what the lender feels comfortable saying: (1) we will likely lend you that money, (2) we feel comfortable with your current financial status and owing us that as a new loan, (3) please go out and search with that pre-approval amount as a limit and let us know what you find. 

The pre-approval amount is guaranteed, however, they also include an estimated interest rate. The interest rate is not stable and can change based on market trends (which we know fluctuate greatly these days week to week). In order to lock in, you have to have a specific house that you’re planning on buying and you lock in on that exact address and rate. 

*A pre-approval is only good for 90 days. While you will likely find a house to lock in on before this time frame is up, it is possible you’ll need to get another pre-approval if you haven’t yet. Keep this deadline in mind as you search.*

What do you need for a pre-approval?

A pre-approval is a soft inquiry on your credit which means it shouldn’t impact your credit score. If you’re embarking on the pre-approval process preemptively to simply see if you qualify or what you could qualify for, it’s not going to negatively impact you. It can however, give you a better understanding of your financial situation and how lenders view that situation. 

If you have a lender you’d like to use, either from your bank, or from a referral, you’ll set an appointment with them (or often this can all be done online). You’ll bring all necessary documents (detailed below), they’ll process it using their software that dictates the lending risk, and let you know what your pre-approval will be. 

Items required for a pre-approval:

• Social security number
• Proof of identity
• Financial history–w2s, tax returns, etc.

What are they looking for?

The primary thing lenders are looking for is your debt-to-income ratio. This means the amount of debt you have per month, and the income you bring in during that same month. Before buying a house, it’s important to reduce all credit inquiries or increases so as to limit your debt and thereby bolster your DTI. This includes new cars, financing furniture or appliances, as well as regular credit card increases. You also want to have a stable or consistent employment history; switching jobs anytime recently can impact your reliability. Lenders want to run the credit check and be able to see dependability to pay back their loan.

Why is it so necessary?

There’s a couple of reasons that a pre-approval is the first step to buying a house. Here’s a few:

1. You can perform all the financial analysis you want, and even have a plan for what you’re willing to spend on a house, but if a bank isn’t going to finance your plan, it’s pointless. A mortgage company giving you a pre-approval is assuring you that if you find a house within their provided limit, they will likely finance you. This way you can house hunt with some light financial assurances and be more prepared in that search.
2. Oftentimes, Real Estate Agents will actually refuse to take you house hunting if you aren’t pre-approved yet. This is mostly due to efficiency for both parties. This saves the agent time because they can narrow down your budget and options accordingly. However, it’s also to your benefit, because it establishes a solid expectation. You likely know what you want in a house (as far as bed and bath counts, location, and age of house). Throw in a max budget item for what you’re truly capable of affording, and your options are a lot easier to sift through. 
3. Being pre-approved also makes it easier for you to put in an offer on a house. This has the dual purpose of making you appear more reliable and serious–something that sellers want. It will speed up the paperwork for putting in an offer, because it cuts out a step already, which means that you can move quickly–a vital quality in today’s market. 

What if you don’t pre-qualify? Or you can’t pre-qualify for the amount you actually need to buy in your area?

This just means you need to do a more long-term review of your finances and start making different choices to achieve your goals. If you want to buy a house, and that’s your first priority, let’s figure out how to get there together. Stairs can help you find government programs that offer grants or specialized loans as well as help you with an investment plan to grow your income, and get you into that house that you want. 

Closing on a house comes with a lot of paperwork. You and all relevant parties will sit down and sign approximately 100 pages about your new purchase. Expect this to take about an hour. The lender wants to ensure that everyone is on the same page (literally!) with how you plan to pay for your new home. They recheck everything to verify that your life and circumstances haven’t changed drastically from when you were first approved for the loan. Primarily, that you are still employed, with the same credit score, and the same savings in your accounts to complete the 30-year transaction. You will need to sign, date, and initial at every instance. Bring a photo ID and know how to initiate a wire transfer with your banking institution. (As a general rule of thumb, going under contract for a home, is not the time to make other big life changes, like career, new large purchases like a car, or getting a sudden influx in cash from your great Aunt. All of these instances could halt or end your contract.) 

The lender then provides a detailed outline of exactly what this decision looks like for all parties involved, much like a receipt—who paid what, when. On the day of closing, the most important number for you is “Cash Needed at Settlement”. This is the exact amount of money—down to the penny—that you need to provide to gain entrance and ownership over your new home. 

What details are on this receipt?

Think of “Cash Needed at Settlement” as your out the door cost; you’ll end up paying more, but that is your grand total for the day. All other items are laid out for you to review as well, but none of them should come as a real surprise. Firstly, because you will have gotten a Closing disclosure a few days before your actual closing appointment. But additionally, most of the remaining details were agreed to in the terms of your purchase contract and negotiated with the seller or builder. The biggest one is your purchase price, how much you bid (or built) your new home for. The closing “receipt” also include Title insurance, Escrow, Recording Fees, Discounts, Prepaid Home owners insurance, inspection fees, any points being applied, and anything else that pertains to the money paid, or to be paid for this property. Taxes and specific fees related to the loan process are the biggest question mark until day-of, but are typically well estimated in your disclosures. 

Sometimes the most confusing estimates at closing is Escrow, which are upfront costs paid into an account as insurance for the lender. Occasionally, the escrow account will be too high or too low resulting in a refund check issued to you after a year of occupancy, or a notice of an increase in your monthly payment to help buoy the premature depletion. 

[Have a mock closing page with numbers here]

What to look out for?

Closing is a dot your I’s and cross your T’s kind of situation; the details matter. Ensure you’re looking for who is responsible for what costs: these are dictated by the negotiations you went through before going under contract for the property. If the seller was paying for the home inspection, but it’s under your column of responsibility, speak up! This is not a time to say you’ve read the terms and conditions when you haven’t. If at any time you have a question or don’t understand where the total came from—ask! Chances are you’ll get a good explanation and feel more at ease, and occasionally you may have caught something that needs clarification. The underwriter may need to reprint a page and have everyone sign (or resign) it, so don’t get too ink-happy. Take your time, read thoroughly, and focus on the task at hand.

If you leave the closing appointment and have terrible buyers remorse, you have 3 days to invoke your “Right of Rescission”. This means you can essentially dissolve the loan and paperwork you signed, and avoid taking out the debt necessary to purchase the house. These don’t happen often, nor do they come without a cost, but it is an option.