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A 401K and a New Home: What You Need to Know

Buying a new home is indisputably a major milestone in anyone’s life. In fact, for most people, it’s the biggest purchase they’ll ever make. Of course, this means that prospective homeowners will need to have their finances in order to afford closing costs, a down payment, and their mortgage once they own the property. 

Saving for retirement is also a very important task, and neglecting your retirement account to pay for a home will likely hurt you in the future. It is completely possible to both save for retirement and have your own home, but to do so, you need to be well informed.
 

The Importance of Financial Literacy

To successfully become a homeowner, you need to have all your ducks in a row before you even start looking. Before you add in a mortgage and home repairs to your monthly budget, make sure you can afford the other necessities. These include payments on any loans, bills, or other living expenses. Also, make sure you can contribute an appropriate amount into your savings accounts and retirement accounts before you consider buying a home. You may not be thinking about these accounts at the moment, but you should start contributing to them early to avoid big regrets later on.

It’s also important to be aware of your credit score when thinking about purchasing a home. All Americans are entitled to one free copy of their credit report per year if you need to see where you stand. When being approved for a mortgage, lenders will look at your credit score to determine at what rate they will lend to you,  if they will lend to you at all. A lower interest rate can save you thousands of dollars over the lifetime of your loan, so it’s important to build a good score before you start house hunting. However, remember that when you look at your credit score, your 401(k) will not count in your debt-to-income (DTI) ratio, nor will it affect your ability to get approved for a loan. This means you can continue saving for retirement worry-free while you shop for your new home. 

Lay the Financial Groundwork 

Once you’ve made sure your credit and budget are up to snuff, it’s time to come up with a financial plan to pay for your new home. Of course, once you’ve closed, you’ll have your monthly payment, as well as property taxes, homeowner’s insurance, and sometimes things like flood insurance or private mortgage insurance. In most cases, you’ll also be required to put a down payment on the property to close. The standard down payment is 20%, but many loan programs will allow you to put down less than this amount. Beyond this, you will also have to pay closing costs, which are often between 2–5% of the total loan amount. Together, these costs add up to thousands of dollars that you must pay all at once. 

Thankfully, you have a few options to help you pay these costs. Many people use the tried-and-true method of using their savings. This way is straightforward, but it will most likely take a long time to save up enough money. If you decide to go this route, it’s best to put your money in a high-yield savings account to gain more money in interest. 

If you don’t want to spend years saving, you can also look into grants and programs that will help you pay your closing costs or lower your down payment. For example, FHA loans only require a 3.5% down payment, as do some conventional mortgage programs.  VA and USDA loans require as little as 0% down if you are able to qualify for these programs. Many programs will also allow friends and family to contribute a “gift” to be put toward your down payment or closing costs. 

If these aren’t options for you, consider withdrawing money from your 401(k) to pay for all or part of your closing costs or down payment. Of course, there are pros and cons to this idea. For example, especially if you are close to retirement age, taking money from your 401(k) means that you have less money during your golden years. It’s also important to know that if you withdraw from a 401(k) account early, you will lose the tax advantages associated with the account. 

That being said, there are times where taking out a loan against your 401(k) can be helpful—note that there’s a difference between withdrawing early and taking out a loan against your 401(k). An example would be when interest rates are low for mortgages, but you can’t afford a 20% down payment on a house. Borrowing from your 401(k) and paying it back could be cheaper than paying for Private Mortgage Insurance (PMI) until you reach 20% equity. This type of loan also doesn’t require a credit check or affect your DTI, as you’re essentially borrowing from yourself. 

Regardless of what you decide to do, it’s important to think all decisions over carefully and tell your lender and real estate agent your plans early on in the process. 

Begin the Journey

Once you’ve created a financial plan to purchase a new home, and made sure your budget and credit score are in good shape, it’s time to begin the process of buying your home! 

The first step in any homebuyer’s journey is to figure out how much you can afford on a home. It’s important to be honest with yourself during this process, as a monthly payment that’s too high can ruin your finances. 

Once this is done, sit down and figure out where you’d like to live, and what home features are a necessity for you. Remember, a house is a large investment, so you’ll want someplace where you can see yourself living for at least five years. Also, consider how your life situation may change while you’re in the home. For example, if you plan on retiring or having children, that will change what features you are looking for, even if you don’t need them now. 

After this, it’s important to get pre-approved for a mortgage. This process involves a hard credit check and submitting some financial information to lenders. Getting pre-approved early in the process will help speed along the escrow period once you’re under contract for a property. It also tells you exactly how much money a lender is willing to loan to you. Lastly, many real estate agents will not show properties unless you have at least one pre-approval letter, so it’s in your best interest to have this step done ahead of time. It’s important to shop around for lenders, so you can guarantee that you’re getting the best deal on a mortgage. It’s also wise to compile all your pre-approvals at the same time, so the credit checks have the least amount of impact on your credit score. 

As a final step, you need to find a real estate agent to help guide you through the process. It’s a good idea to interview a few different agents and go with whomever you feel the best about. Your realtor will be the one scheduling house showings, putting in purchase offers on your behalf, and walking you through the homebuying process, so you want to make sure you can trust whomever you choose. The good thing is, in most cases, the home seller pays the fees for both the buyers’ agent and their own agent. This means that a real estate agent is likely a free resource to help you purchase a home! 

Buying a home is a stressful experience for many. This is especially true when you add in other responsibilities like student loans, car payments and retirement savings. However, if you plan ahead, taking care of all these things and having a new home is completely doable.

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