Duane Buziak, NMLS #1110647, hears the same question from buyers who are a few thousand dollars short of closing: should I borrow from my 401(k) or withdraw from it? Both routes put retirement money into a down payment, and they cost very different things. A loan is mostly a cash-flow and job-risk decision. A withdrawal is a permanent tax and growth decision.
The seven strategies below are meant to be used in order. They cover the mechanics of a 401(k) loan vs withdrawal for a down payment, the arithmetic, the plan and job risks, the effect on your mortgage file, and the alternatives that may mean you never have to choose. Every bracket, rate, and growth figure here is an assumption for illustration, not a forecast.
1. Learn how a 401(k) loan and a hardship withdrawal actually differ
A plan loan lets you borrow from your own vested balance (the portion that is legally yours, including your contributions and any vested employer match). You repay principal and interest back into your own account through payroll deductions. Under IRS rules, the loan is generally capped at the lesser of $50,000 or 50% of your vested balance, and the cap is reduced by any loan balance you carried in the prior 12 months. Loans used to buy a primary residence can often have a repayment term longer than the usual five years, if the plan allows it. The IRS page on retirement plan loans lays out the limits.
A hardship distribution is permanent. Buying a principal residence is one of the recognized reasons, but the amount is limited to what you need, it is taxed as ordinary income, and the 10% additional tax on early distributions generally applies if you are under 59½. The money does not go back in. The IRS explains the rules on its hardship distributions page.
Consider an illustration: a 34-year-old has a $120,000 vested balance. Half is $60,000, but the $50,000 cap applies, so the most she could borrow is $50,000. If she withdrew instead, every dollar would be taxable income that year, plus the 10% additional tax.
The mistake to avoid
Many buyers have heard of a $10,000 first-time homebuyer exception to the early-withdrawal tax. That exception applies to IRAs, not to 401(k)s. The IRS lists the exceptions on its exceptions to early distribution tax page, and it is worth reading before you assume anything.
How to put it into practice
- Request your plan’s Summary Plan Description from HR or the plan portal.
- Find the sections on loans and hardship distributions.
- Cross-check the limits against the IRS pages above, since rules, including SECURE 2.0 changes, are updated over time.
What to measure: the number of plan rules you have confirmed in writing: loan cap, hardship eligibility, and repayment term. Three out of three before you decide anything.
2. Run the worked dollar comparison before you choose
Start with a target of $60,000 in net cash. The loan and the withdrawal produce that cash at very different prices, and only the arithmetic shows the gap.
Withdrawal (labelled illustration). Assume a 34% combined rate: 24% federal bracket plus the 10% additional tax, with state tax left out for now. To net $60,000 you must withdraw $60,000 ÷ 0.66 = about $90,900. Roughly $30,900 goes to taxes. If that $90,900 would otherwise have grown at an assumed 7% for 25 years (a factor of about 5.43), it would have become roughly $493,000. For comparison, over 5 years the lost growth is about $36,600 (factor 1.40), so the 5-year cost is about $30,900 in tax plus $36,600 in forgone growth, or about $67,500.
Loan (labelled illustration). The $50,000 cap applies in the earlier example, so assume a $50,000 loan at an assumed 8% over 5 years. The payment is about $1,014 a month, or $60,846 in total, and about $10,846 of that is interest paid back into your own account. If the account would have earned about 7% anyway, the interest roughly offsets the growth you gave up. The real cost is the $1,014 a month, paid from after-tax pay, and any contributions you reduce to afford it.
Duane Buziak, NMLS #1110647, walks clients through this same side-by-side before anyone signs a plan form. A NoTouch Credit Process pre-qualification can run at the same time, so you see your cash-to-close target without a hard inquiry on your credit.
Common mistakes and how to fix them
The two most common errors are forgetting state income tax, and forgetting that a $90,900 withdrawal stacks on top of your salary and can push part of your income into a higher bracket than the 24% assumed. Both make the withdrawal look cheaper than it is.
- Gross up the withdrawal: net needed ÷ (1 minus your estimated total tax rate).
- Amortize the loan at the plan’s actual rate and term.
- Add the missed growth for each option.
- Put both side by side in a spreadsheet and run a second version with a higher tax rate.
What to measure: total cost at 5 years and at 25 years for each option. Ask a CPA to confirm your tax figures; this is not tax advice.
3. Check whether your plan even allows the option you want
Federal rules set the outer limits, but your employer’s plan decides what actually exists. Some plans offer no loans. Some allow hardship withdrawals but not loans, or only one loan at a time. Others charge a loan setup fee, an annual maintenance fee, or set an interest rate and term that differ from what you assumed in the spreadsheet.
Timing is the part buyers underestimate. Imagine a buyer under contract with a 30-day closing who learns the plan takes 15 business days to process a loan request, plus a few days for the check or transfer. By moving the request up, ahead of the contract deadline, she keeps her closing date. If she had waited until the final week, she might have had to ask the seller for an extension.
Questions for the plan administrator
- Are loans and hardship distributions both available for a home purchase?
- What are the fees, the interest rate, and the maximum repayment term for a primary-residence loan?
- How many business days from request to funds in hand?
- Are contributions suspended or reduced while a loan or hardship withdrawal is active?
- What documentation is required (for example, a purchase contract)?
Get the answers by email or in a plan document, not only by phone, so you can pass them to your broker if needed.
The common mistake is starting the paperwork late. The fix is simple: ask on day one of your house search, not on the day you go under contract. Buyers who get pre-approved for a home loan early tend to learn their cash-to-close number with enough time to line up plan paperwork.
What to measure: days from request to funds in hand compared with days remaining until closing. Leave a buffer of at least a week.
4. Factor in job-change risk with a loan
A loan feels safe because you are paying yourself. The hidden risk is that the repayment is tied to your paycheck. If you leave or lose your job, the plan may require the remaining balance to be repaid on a short timeline. If it is not repaid, the outstanding amount is treated as a distribution, generally taxable and, if you are under 59½, generally subject to the 10% additional tax. Current law gives you until your tax filing deadline, including extensions, to roll over the offset amount to an IRA or another plan, but you must find the cash to do it.
For example, imagine a layoff while $35,000 is still outstanding. With an assumed 24% bracket plus the 10% additional tax, the tax bill is about $35,000 × 0.34 = $11,900, owed at a moment when income has just dropped. If you can roll over $35,000 from savings by the deadline, you avoid it. If you cannot, you pay it.
The mistake is assuming the loan can always continue after you leave. Some plans allow continued repayment by direct payment; many do not. Your plan documents will say.
- Confirm the plan’s post-separation repayment rules in writing.
- Estimate the tax bill if the loan balance were treated as a distribution.
- Build a cash reserve that covers that bill, or plan how you would roll the amount over.
- Consider the stability of your industry and employer before choosing a loan over other options.
What to measure: months of living expenses held in reserve compared with the loan balance. If a layoff would force you to choose between rent and a tax bill, a loan carries more risk than it appears to.
5. Understand how each option affects mortgage qualification
Your down payment source has to be documented, and the way the money arrives matters. A withdrawal usually needs the plan’s distribution statement and proof that the net funds landed in your bank account. A loan needs the loan terms and the same deposit evidence. Funds that appear unexplained in a bank account can trigger extra questions, so give your broker the plan statements early. The Fannie Mae Selling Guide sets the documentation standards for conventional loans, and other programs have their own rules.
Debt-to-income (DTI) treatment and reserves are where programs differ. Whether a retirement loan payment counts in your DTI, and how much of your retirement balance counts toward reserves, depends on the program and the investor. Seasoning, meaning how long funds have sat in your account, is another factor: funds that arrive just before closing get more scrutiny.
A cautionary illustration: a jumbo buyer (loan amounts above the 2026 conforming limit of $806,500) drains a retirement account to reach 20% down, then discovers the program requires several months of post-closing reserves and the account that would have counted is now nearly empty. Jumbo and some Non-QM programs often ask for more reserves than conventional conforming loans, so this trap is real for move-up buyers. Our guide to jumbo loan down payment requirements covers how much you really need to put down.
The fix is to ask early. A NoTouch Credit Process pre-qualification lets Duane Buziak review your scenario without a hard credit inquiry, and you can ask specifically how the program treats retirement loans, withdrawals, and reserves.
The mistakes are failing to document the source of funds, and assuming reserves are unaffected by the draw.
What to measure: your remaining post-closing reserves, in months, compared with the program’s requirement.
6. Compare alternatives that may beat both: DPA, gift funds, and lower-down programs
The cheapest dollar to take out of retirement is the one you never take. Several programs reduce the cash you need at closing, and they should be priced before any retirement draw. For a broader menu, see these down payment solutions when you can’t afford to put money down.
- FHA: as little as 3.5% down for qualifying borrowers. Our FHA loan down payment requirements page has the details.
- VA and USDA: eligible borrowers may be able to buy with no down payment.
- Down payment assistance: Dynamo DPA (assistance options of 2.5% or 3.5%, with a 580 minimum FICO) and Turbo DPA (3.5% or 5%, 600 minimum FICO). Eligibility, property, and income rules vary by program and can change. See down payment assistance programs by state for how to use them without overpaying long-term.
- Gift funds: permitted under many programs from acceptable donors, with a gift letter and a paper trail. Review the gift funds for down payment rules before you accept money from a relative.
The arithmetic is plain. On a $350,000 purchase, 3.5% down is $12,250, while 10% down is $35,000, a difference of $22,750. Closing that gap through a retirement withdrawal at an assumed 34% combined tax would mean withdrawing about $34,500 gross ($22,750 ÷ 0.66), which is a large permanent cost to avoid a smaller monthly payment.
The common mistake is focusing on avoiding mortgage insurance and draining retirement to do it. Mortgage insurance is a monthly cost that can often be removed later or lowered by refinancing. Lost retirement growth cannot be refunded.
- Ask your broker to price two or three structures, such as FHA with and without DPA and a conventional low-down option.
- Put cash to close and the total monthly payment (including mortgage insurance) in one comparison.
- Only then decide whether any retirement money is still needed.
What to measure: cash to close and total monthly payment under each structure. As an independent broker, Duane Buziak can price these side by side across programs.
7. Weigh the long-term cost of lost retirement growth
The most expensive part of touching a 401(k) usually does not appear on the closing statement. Money pulled out at 34 stops compounding for the next three decades. As a labelled hypothetical, $40,000 at an assumed 7% for 25 years grows by a factor of about 5.43 to roughly $217,000 (40,000 × 5.43). That is the amount you give up, before any taxes on later withdrawals.
The loan has its own version of this cost. If you reduce or stop contributions to afford the repayments, you give up new growth as well. The biggest hidden loss is the employer match. Suppose, as an assumption, your employer matches 4% of a $90,000 salary, or $3,600 a year. Pausing contributions for two years to cover loan payments forfeits $7,200 of match money, plus the growth it would have earned.
The mistake is pausing contributions entirely. If cash flow is tight, contribute at least enough to capture the full match and let the loan payment come out of other spending. Knowing how much house you can afford before you shop also keeps you from stretching your budget and raiding retirement to compensate.
- Run a compound growth calculation for the amount you would pull, using conservative and optimistic return assumptions.
- Keep contributions at or above the employer match level.
- If you borrow, set up automatic payroll repayment so the balance returns to the account on schedule.
- Re-check the numbers with a CPA or financial planner.
What to measure: your projected retirement balance at age 65 with and without the draw. If the gap is larger than the benefit of closing sooner, look again at strategy 6.
Where to start, and how to test your own numbers
Begin with strategies 3 and 2: confirm what your plan permits and how long it takes, then run the dollar comparison with your own balance and tax rate. Before you touch retirement money, work through strategy 6 and price DPA and low-down programs, because they may shrink or erase the gap. If you still need retirement funds, the loan generally costs less than the withdrawal, as long as your job is stable (strategy 4) and your file still meets reserve requirements (strategy 5).
Talk to Duane today at Mortgage Shopping (Supra Mortgages / Duane Buziak Mortgage Maestro). Stop overpaying on your mortgage and discover wholesale rates that could save you thousands over the life of your loan, with a no-obligation rate comparison, no credit impact, and independent mortgage expertise. The right mortgage is the one that fits your plans, not just the one with the lowest number on a rate sheet.