I've received several (actually dozens) of emails asking about whether buyers should borrow money from their 401K accounts to help buy a house. [disclaimer] I'm not a financial expert so don't listen to anything I say! But, here's my opinion anyway.
I looked into this because I'm a little short in my down payment account. Yes, I know if I'd taken a few less vacations last year, I'd be in better shape. I came to the conclusion that this was a bad plan for me. Having a smaller DP and putting up with mortgage insurance for a few years seems like a better way to go. With decent credit you can still get a loan with 10% down as long as you can fully document your income and your DTI is reasonable. You will get stuck with mortgage insurance if your DP is less than 20%. The insurance usually runs around .05%($200/mo on a $400k loan).
I was looking at borrowing $40k for the additional 10% on the down payment. That would lower payments by about $200/mo and save me the $200/mo insurance for a net savings of about $400/mo. However I have to repay the loan. If I choose to repay that $40k over 5 years the monthly payment is $800/mo. So it's costs me an additional $400/mo for the first 5 years. After crunching all the numbers it did not make sense for me to borrow from my 401k.
There are risks and costs involved with Borrowing from your 401K. First off you have to pay it back with interest (which is often credited to your account, so you are paying interest to yourself). You pay it back using after tax dollars though. It does not get paid back using your usual 401k deduction. Then when you pull out that money later you are taxed again. Basically you get taxed twice on that "loan". So it does end up costing you a lot more than a regular loan. If you lose your job, normally you are required to pay the loan off in full. If you cannot that is then treated as a withdrawal and you get taxed on it AND penalized for an early withdrawal. This can be very costly.
Not all companies will allow you to Borrow from your 401K. If yours does not then you have to make a hardship withdrawal. Those are subject to full income taxes on your next years taxes. So you will want to put some of the amount you withdraw into the bank to pay next years taxes.
We are all in different situations and you should probably talk with your 401k administrator and a financial adviser (not some blogger) before pulling cash from your 401K. For me. it did not make sense to consider this path. The costs were too high as were the risks in order to save $200/mo.
Now, let the real financial experts chime in!