A 401(k) loan for a mortgage lets you borrow from your own retirement account to help buy a home, up to $50,000 or half your vested balance, whichever is less. The appeal for buyers is the repayment term: standard 401(k) loans must be paid back within five years, but loans used to purchase a primary residence can stretch to 10, 15, or even 20 years under most plans. You’re the borrower and your plan is the lender, with your vested balance acting as collateral.
Whether it’s a good idea is a different question, and the answer depends on how much you borrow, how secure your job is, and what the money would have earned if you’d left it alone.
How Much You Can Borrow
The IRS caps 401(k) loans at the lesser of two amounts.1Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts The first is $50,000, reduced if you’ve had other 401(k) loans in the past 12 months. If your highest balance over that period was $30,000 and you’ve paid it down to $10,000, you subtract $20,000 from the cap, leaving $30,000 available.
The second is the greater of 50% of your vested balance or $10,000. The $10,000 piece acts as a floor: if you have $16,000 vested, half would be $8,000, but you can still borrow up to $10,000.2Internal Revenue Service. 401(k) Plan Fix-It Guide – Participant Loans Don’t Conform to the Requirements of the Plan Document and IRC Section 72(p)
Your actual maximum is whichever of those two numbers is smaller. The $50,000 ceiling applies to total borrowing across all loans from the plan, not to each loan separately.3Internal Revenue Service. Retirement Plans FAQs Regarding Loans
Not every 401(k) allows loans in the first place. The plan document has to permit them, and plans can impose their own additional restrictions, like a minimum loan amount or a cap on how many loans you can have outstanding.3Internal Revenue Service. Retirement Plans FAQs Regarding Loans
Interest Rate and Repayment
The IRS requires the rate to be comparable to what a commercial lender would charge for a similar secured loan.2Internal Revenue Service. 401(k) Plan Fix-It Guide – Participant Loans Don’t Conform to the Requirements of the Plan Document and IRC Section 72(p) Most administrators set it at the prime rate plus one or two points, and the rate is fixed for the life of the loan. The interest you pay goes back into your own account, but a higher rate still means larger payroll deductions, which pinches your take-home pay and can affect your mortgage qualification.
Payments must follow a substantially level amortization schedule with installments at least quarterly.1Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts In practice, almost every plan collects the money through automatic payroll deduction.
The Primary Residence Exception
If the loan is used to buy your principal residence, the five-year repayment limit doesn’t apply. Plan documents commonly allow 10, 15, or 20 years to pay it back.4Internal Revenue Service. Retirement Topics – Plan Loans The longer term has to be written into the promissory note, and you’ll need documentation showing the property will be your primary residence, usually a signed purchase contract or settlement statement.
Miss a payment and the plan may offer a cure period. The longest it can run is the end of the calendar quarter after the quarter in which the payment was due.5Internal Revenue Service. Issue Snapshot – Plan Loan Cure Period Blow past that and the whole outstanding balance becomes a taxable distribution.
How to Apply
The process is much simpler than a mortgage application. You submit a request through your plan’s record keeper, often online, specify the amount, and indicate the funds are for a primary residence purchase. The administrator confirms your vested balance, checks any existing loans against the IRS limits, and reviews your supporting documents if you want the extended repayment term.
Once approved, you sign a promissory note setting out the amount, rate, schedule, and term. Funds typically arrive within about ten business days. No federal tax is withheld, because a loan in good standing isn’t a distribution.
If your plan provides a qualified joint and survivor annuity, your spouse may have to consent to the loan in writing, since borrowing against your vested balance reduces the benefit they’d receive if you died before retirement.6Internal Revenue Service. Fixing Common Plan Mistakes – Failure to Obtain Spousal Consent Plans in community property states may require spousal consent regardless. Your administrator will tell you if it applies.
How It Affects Your Mortgage Application
A 401(k) loan does not appear on your credit report. It isn’t a tradeline the credit bureaus track, so on-time payments won’t help your score and the balance won’t show up when a mortgage lender pulls your file.
The debt-to-income picture is less clean. Some underwriting systems ignore 401(k) loan repayments because the money is coming out of retirement assets rather than earned income. Others count the monthly repayment against you, particularly when payroll deduction visibly cuts your take-home pay. If your DTI is already close to the qualifying line, that added obligation can tip you from approval to denial.
Underwriters also look at what the borrowing did to your retirement balance overall. Draining the account or pausing contributions to afford the payments can read as a sign of financial strain. The cleanest position is to borrow a modest share of the balance and keep making regular contributions throughout the loan.
The Interest Is Not Deductible
This is where many homebuyers get the math wrong. Interest on a conventional mortgage is generally deductible. Interest on a 401(k) loan is not, in almost every real case: IRS rules disallow the deduction when any part of the account balance came from elective salary deferrals, which covers essentially every 401(k).
If you’re comparing a 401(k) loan to a traditional home loan at a similar rate, the after-tax cost of the 401(k) loan is higher than the stated rate suggests. The mortgage can end up cheaper on an after-tax basis even when the headline rates look the same.
What Happens If You Default
A default triggers what the IRS calls a deemed distribution. No cash changes hands, but the full unpaid balance is treated as a taxable withdrawal in the year of the default and gets added to your gross income, potentially pushing you into a higher bracket.7Internal Revenue Service. Fixing Common Plan Mistakes – Plan Loan Failures and Deemed Distributions
If you’re under 59½, the IRS also adds a 10% early distribution penalty on top of the regular income tax.8eCFR. 26 CFR 1.72(p)-1 – Loans Treated as Distributions For someone in the 24% bracket who defaults on a $40,000 balance at age 45, that’s $9,600 in tax plus a $4,000 penalty, before any state tax.
Leaving Your Job With a Balance
This is where most 401(k) home loans fall apart. Many plans require full repayment of the outstanding balance when you separate from your employer.4Internal Revenue Service. Retirement Topics – Plan Loans The deadline varies, but the window is almost always short.
If you can’t pay in time, the plan offsets the balance against your vested account. A plan loan offset that results from termination of employment qualifies as a “qualified plan loan offset amount,” which gives you until your tax filing deadline, including extensions, for that year to roll the offset into an IRA or another eligible plan and avoid tax on it.9Federal Register. Rollover Rules for Qualified Plan Loan Offset Amounts
That rollover is a lifeline, but it still requires cash from somewhere else to deposit into the IRA. If you borrowed $35,000 and owe $28,000 when you leave, you need $28,000 in hand to complete the rollover. People who’ve just lost a job rarely have that money sitting around, which is why so many of these offsets end up fully taxable with the 10% penalty attached.
Loan vs. Hardship Withdrawal
Some plans also allow hardship withdrawals for the purchase of a principal residence, which the IRS lists as an eligible hardship under its safe harbor rules.10Internal Revenue Service. Retirement Topics – Hardship Distributions The differences are significant:
- A loan gets repaid to your account. A hardship withdrawal is permanent and cannot be rolled into an IRA or returned to the plan.
- A loan in good standing isn’t taxed. A hardship withdrawal is taxed as ordinary income and may trigger the 10% early distribution penalty if you’re under 59½.
- A hardship withdrawal is limited to the amount actually needed for the purchase.
The loan is usually the better option when your plan offers both. You keep the money inside the retirement system, you avoid immediate tax, and you rebuild the balance through repayments. The one situation where a hardship withdrawal makes more sense is when you expect to leave your employer soon and know you won’t be able to repay the loan in the short window after separation.
The Real Cost: Lost Growth
The largest cost of borrowing from a 401(k) for a home isn’t the interest rate or even the risk of default. It’s the market returns you forfeit while that money sits outside your investments. A $40,000 loan repaid over 15 years means a meaningful chunk of your portfolio is earning loan interest instead of compounding during your peak saving years.
The pattern is consistent: the longer the term and the larger the loan relative to your balance, the more retirement income you give up. The primary residence exception that makes monthly payments manageable also extends the stretch of years your money is out of the market.
Before you borrow, run the numbers through your plan’s loan modeling tool or a retirement calculator. Compare the full cost, including lost growth, non-deductible interest, and the risk of job separation, against the alternatives: a smaller down payment from cash savings, a conventional loan with PMI, or an FHA loan. For many buyers, the 401(k) loan looks cheapest on paper and turns out to be the most expensive option over a full career.