Finding the money to pay for an addition to your home, whether it be a master suite, an extra bedroom, or a new playroom, can be difficult. You could look for other financing options or take out a second mortgage, but some people choose to use their 401(k) as a source of additional funds. Some strategies let you take out a short-term loan and pay it back with interest. This can seem like a good deal because you’re essentially paying interest to yourself, but think about all the benefits and drawbacks of this strategy before you take any action.
Check with your plan administrator to see if you can use the funds to finance your home addition as not all 401(k) plans permit you to borrow money. You must still be employed by the company where you have your 401(k) in order to borrow money from it, and you must pay it back with payroll deductions. You will be responsible for penalties and interest on the amount you withdraw if you don’t pay back the loan within the stipulated time frame.
Amount You May Borrow
You are only permitted to borrow up to $50,000, or 50% of the value of your 401(k). You’ll need to find financing elsewhere if your home addition will cost more than this amount. The amount you can borrow will be decreased by the amount of the initial loan if you’ve already borrowed money from your 401(k) and any portion of that sum was due in the year prior to your new borrowing request. For example, if your 401(k) is worth $100,000 and you borrowed $10,000 last year, paying it off three months ago, you would only be able to borrow $40,000 because you didn’t pay off the previous loan more than a year ago.
Any loan you take out from your 401(k) must be repaid within five years, and you must make a series of even payments, at least once per quarter. Principal and interest at a rate corresponding to one or two percentage points above the prime rate will be included in the payments. Even if you’re taking home a smaller paycheck, your income needs to be enough to cover your other obligations because the funds to make the payments will be taken out of it. You must pay back the loan in full within 60 days if you quit your job or are fired, so you’ll need a backup repayment strategy in case that happens. Some plans prohibit additional contributions while you are repaying your loan. Your retirement account’s balance won’t receive the tax credit for your contributions, and it will grow less quickly.
When you’re building an addition onto a house, the house can serve as a source of funding for the project. You might be eligible for a home equity loan if you’ve accrued equity in your property. You can repay these loans over a longer period of time if necessary, they frequently have lower interest rates than 401(k) loans, and you won’t have to worry about having to pay the full amount of the loan at once if you lose your job. If you itemize your taxes, the interest you pay on a home equity loan is tax deductible; however, the interest you pay on a 401(k) loan is not.
Author of numerous novels, Cynthia Myers has also contributed nonfiction essays to magazines like “Historic Traveler,” “Texas Highways,” and “Medical Practice Management.” She graduated from Sam Houston State University with a degree in economics.
Can you borrow from your 401k for home improvement?
Generally, you can’t take money out of a 401(k) until you quit your job. Nevertheless, you might be eligible for a hardship withdrawal because you need the money for home repairs due to storm damage. Rules for hardship withdrawals differ significantly from one plan to another. Some plans don’t allow them at all.
What is the penalty to borrow out of 401 K for home repairs?
If you are under 59 12 and take a hardship withdrawal from your 401(k) to pay for home repairs, you will also be charged a 10% withdrawal penalty in addition to income tax.
Can I use a 401k loan for anything?
Some 401(k) plans only permit employees to borrow money to cover education costs for a spouse or child or uninsured medical expenses. They can also use loan money for general financial hardship or as a down payment for a home purchase in other situations.
Can I take a hardship withdrawal from my 401k for home repairs?
Eligibility for 401(k) Hardship Withdrawals Avoid foreclosure or purchase a primary residence Cover educational expenses for you, your spouse or your dependents. Pay for family funeral expenses. Pay for specific types of home repairs, like those required following a natural disaster