Using 401(k) retirement for downpayment

Faced with tightened lending standards at a time when home values are dropping, more people are borrowing money from their 401(k) retirement plans to help swing a downpayment to buy a home.

But before you think that borrowing from your employer-sponsored 401(k) retirement plan (or a 403(b) if you work for a school or nonprofit) is the ticket to buying a home, realize this strategy has pros and cons.

On the plus side, the loan principal, along with the interest on the loan, is paid back to you and is lower (currently in the 6.5 percent range) than a bank typically charges. Also, there is no credit check required, since you are lending yourself the money.

On the negative side, taking out a loan could reduce the retirement account's long-term growth and earning potential significantly, especially if you stop making contributions while paying off the loan. (If you can. Not all plans allow you to make contributions while your loan is active). There is also a tax hit if the loan is not repaid.

Whether you can actually borrow from a 401(k) is up to the plan sponsor, your employer. About half the plans sponsored by the nation's employers, which collectively reach about 85 percent of the nation's 47.2 million 401(k) account holders, allow loans, according to industry statistics. Borrowing typically is capped at $50,000, or up to half of the vested amount, but requires a minimum loan amount of $10,000.

"Borrowing against your 401(k) is a very dumb idea," said Jim Titus, a vice president and financial consultant in the San Francisco headquarters of stock broker Charles Schwab & Co. "You end up losing the (tax-deferred growth potential) when you take the money out of your 401(k) and the interest you pay back (on the loan) is unlikely to earn as much of a return as your 401(k) investment."

That said, there are reasons to consider borrowing from a retirement plan to take advantage of the steep drop in home prices.

The meltdown has made lenders reluctant to provide no-money-down loans or piggyback lending, which amounts to two mortgages packaged together to finance a home purchase.

"I'm seeing a lot of people touch up on their retirement accounts for downpayment money," said Dianne Crosby, a senior loan consultant in the Oakland, Calif., office of LaSalle Financial Services. "What's going on from a lending perspective is that lenders are requiring a much larger downpayment than they did a year ago, preferring 20 percent down, accepting 10 percent down with mortgage insurance. But prices are coming down on homes. There is a willingness to tap into retirement (funds) ... Right now, real estate in a depressed market, I think it's a great investment."

One question people have to ask is whether they would be better off taking out a retirement fund loan and using it for a downpayment or waiting until they accumulate additional funds, said Gary Gardner, a certified financial planner and president of LifeWealth Advisors.