Consider other funds before using 401(k) for house down payment

Q: Can I tap into a retirement account to help with my down payment?

A: Ideally, the money you use for a down payment should be savings you've specifically set aside for a home. But if a lender demands more up-front cash than you expected, an Individual Retirement Account or 401(k) may be the only place you can turn for another $10,000, $20,000 or more.

If that's the case, tap a Roth IRA or Roth 401(k) plan first.

Since contributions to Roth plans are fully taxed before they're made, you can withdraw however much you've put into those accounts at any time without incurring any penalties or additional taxes.

If you've held a Roth IRA for at least five years, you can withdraw an additional $10,000 in earnings without paying any penalties or taxes to buy or renovate a first home. The next place you should turn is a traditional IRA, which will allow you to withdraw up to $10,000 for the purchase of a first home without penalty.

If you and your spouse each have a traditional IRA, then you can take $10,000 or a total of $20,000 from your two accounts penalty-free. But since contributions to traditional retirement accounts such as this are tax-deductible, you'll have to pay income tax on withdrawals that exceed those limits.

Any withdrawals above the limits are subject to income tax and a 10 percent penalty until you reach 59½ years old.

Q: Can I take money from my 401(k) plan?

A: Your employer's traditional 401(k) plan is the last place you should turn for a down payment.

It has no special provisions for down payments, and any "hardship withdrawals" are fully taxed and incur a 10 percent penalty until you turn 59½.

The better option is to take a loan out against your 401(k) account. You can usually borrow up to $50,000 or half the value of the account, whichever is less, and take up to five years to pay it back.

The interest you're charged, which is generally a couple of percentage points above the prime rate, goes into your retirement account and the monthly payments are deducted from your paycheck. You're talking about a new monthly expense that will reduce the amount you can afford to borrow for a home.