How Does Borrowing From A 401k Or IRA To Buy A House Work?

Are you thinking about borrowing from a 401k or IRA to buy a house? More people are thinking about it given real estate is a fantastic asset class to build wealth long term. Over time, your house's principal value goes up and the real cost of the mortgage goes down. In an inflationary environment, the tailwind for housing is even greater.

If you're a first-time home buyer, you can borrow from your 401k or IRA to buy a house. However, just because you can borrow from a 401k or IRA to buy a house doesn't mean you should. Your 401k or IRA is for your retirement future. By borrowing from them, you could hurt your finances when you are too old to want to make more money.

The key to a large 401(k) portfolio is to consistently max it out and let your investments compound. The longer you give your 401k or IRA time to compound, the better.

401k Savings Targets By Age

Here's a chart that should motivate you to stay on track with your 401(k) contributions. Eventually, you will be a millionaire if you stay the course.

401k savings targets by age

Let's say my 401(k) by age chart doesn't convince you to keep your pre-tax retirement accounts and your real estate investment accounts separate.

How Much Can You Borrow From Your 401k To Buy A House?

The IRS allows you to borrow against your 401k, provided your employer permits it. If your plan does allow loans, your employer will set the terms.

The maximum loan amount permitted by the IRS is $50,000 or half of your 401k’s vested account balance, whichever is less. During the loan, you pay principle and interest to yourself at a couple points above the prime rate, which comes out of your paycheck on an after-tax basis.

Generally, the maximum term is five years, but if you use the loan as a down-payment on a principal residence, it can be as long as 15 years. But who plans to stay at an employer for 15 years anymore? Not many.

Borrowing from your 401k is a good alternative because you do not need a credit check, nothing appears on your credit report, and interest is paid to you instead of a bank or credit card company.

You can also utilize the 60-day rollover rule to borrow from your 401(k) or IRA. Just remember, borrowing money means paying it back, otherwise there will be penalties.

Borrowing from An IRA For First-time Home Buyers

Another thing to note. If you have an IRA, you can take up to $10,000 out of your IRA penalty-free for a first-time home purchase. If you are married, your spouse can do the same – and “first-time home” is defined pretty loosely.

Borrowing From Your 401k To Buy A Home Is Not Optimal

I understand the FOMO of wanting to own your property, or at least own your own house so you can stop paying rent. Real estate FOMO is the illest. It's the American dream. Unlike owning stocks, which provide no utility or joy, at least with a house, it provides shelter and you can create wonderful memories with loved ones.

However, withdrawing from your 401(k) to the borrow money from the bank to but your first home at this point in the cycle is madness. Prices are at all-time highs in many parts of the country. Although I believe house prices will go higher for several more years post pandemic, you just never know.

2021 Home Price Prediction

Borrowing from your 401k or IRA to buy a home means you are borrowing money to borrow more money. Such a move could literally wipe away your entire net worth in a few short years if the real estate market turns south and you've got to sell. That's what happened with many homebuyers in 2007-2008.

Alternative To Borrowing From 401k Or IRA To Buy A Home

Instead of borrowing from your 401k or IRA to buy a home, you're much better off building your after-tax savings and investments that can provide for a 20% downpayment. If you don't have at least a 20% downpayment in cash plus a buffer equal to 10% of the value of the house, you probably cannot afford to buy your first home.

Leverage is great on the way up, but terrible on the way down.

Renting is good value now in many parts of the country, especially if you live in an expensive coastal city. Take a look at my BURL strategy if you really want to invest in real estate.

The pandemic hit tiger cities like San Francisco, San Jose, DC, and New York City harder than 18-hour cities. Therefore, renting in big cities is a good deal.

Instead of borrowing from 401k or IRA to buy a property, considering renting

For example, if it sounds absurd to pay $4,200 a month in rent for a two bedroom, two bathroom apartment in San Francisco, it is even more absurd to spend $1,350,000 buying the place!

At $1,350,000, the apartment is trading at 26X annual gross rent or just a 3.6% gross yield. After property tax and expenses, we're talking under a 3% net rental yield (cap rate), and that's assuming no mortgage!

However, buying real estate in big cities is a relatively better deal nowadays. Therefore, if you have been waiting to buy in places like New York City or San Francisco, the time is now as rents tick back up post pandemic.

Instead of borrowing from 401k or IRA to buy a property, considering renting

Personally, I sold one expensive San Francisco rental home in 2017 and reinvested $550,000 of the proceeds into real estate crowdfunding investments in the heartland of America.

Valuations are so much cheaper and the net rental yields for earning passive income are so much higher. There's no reason anybody needs to live in a congested and super expensive coast city any more when technology allows all of us to be mobile. Further, companies can't afford to pay such high wages anymore.

Invest On The Best Platforms

With real estate crowdfunding, you don’t need to risk $100,000 or more to invest in commercial real estate. Instead, you can invest for much lower amounts such as $5,000. The best real estate crowdfunding platforms today are:

1) CrowdStreet, founded in 2014, is based in Portland and connects accredited investors with a broad range of debt and equity commercial real estate investments. CrowdStreet is great because they focus primarily on 18-hour cities (secondary cities) with lower valuations, higher net rental yields, and potentially higher growth. Just make sure to review each sponsor as you build your select real estate portfolio.

2) Fundrise, founded in 2012 and available for non-accredited investors. I’ve worked with Fundrise since the beginning, and they’ve consistently impressed me with their innovation. They are pioneers of the eREIT product. Fundrise manages over $3.3 billion and predominantly investments in the Sunbelt region.

Both of these platforms are the oldest and largest real estate crowdfunding platforms today. They have the best marketplaces and the strongest underwriting of deals. Investors should carefully consider their own investment objectives when assessing the gamut of real estate opportunities that are available.

How does borrowing from a 401(k) or IRA to buy a house work?
Examples of real estate crowdfunding investments

Try Not To Borrow From Your 401k Or IRA To Buy A House

Please don't withdraw from your 401k or IRA to buy a house. Let your pre-tax retirement contributions grow and compound over time. Keep your FOMO for a house at bay. There's nothing wrong with renting until you can comfortably afford to raise capital specific for your house purchase.

Work on building up the value of your 401k while concurrently building up your real estate capital. If you do, you'll be much better off when it's time to finally retire. In retirement, you need to count on your 401k, your after-tax investments, and your side hustle to live comfortably.

No longer can you rely on a pension or Social Security. Yes, you will ideally also have a paid off house too. But to do so, you need to buy a house you can actually afford first.

If you can't buy a house following my 30/30/3 rule for home buying, then you can't comfortably afford to buy a house. Use patience and discipline when investing. While you are building your down payment, you can invest in a real estate ETF, a publicly traded REIT, or a private eREIT like the ones offered by Fundrise. The idea is that you want to ride the ups and downs of the real estate market so you don't fall behind.

About the Author: Sam started Financial Samurai in 2009 as a way to make sense of the financial crisis. He proceeded to spend the next 13 years after attending The College of William & Mary and UC Berkeley for b-school working at Goldman Sachs and Credit Suisse. He owns properties in San Francisco, Lake Tahoe, and Honolulu and has $810,000 invested in real estate crowdfunding.