Using Retirement Funds to Buy a HomeDaniel Dobbs2023-05-25T20:41:10-07:00
Whether it’s first time, boomerangs or move up buyers, the down payment is often the biggest obstacle to home ownership.
Credit scores can be boosted, promotions/job changes can increase income & debt can be paid off /down …(all issues best left to your loan officer) but the down payment remains the biggest challenge.
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In addition to down payment, typical closing costs (even with a “no point” loan) will add another 1-2% to the transaction’s cost.
That figure includes up t 9 months of tax impounds, the 1st month house payment and a 14 months of insurance.
Which begs the question “how to get the down” & “how much is needed”?
Many buyers have retirement accounts but are hesitant to access the funds because of a lack of understanding on how their specific account and processing work.
And a lack of understanding is not something they will readily disclose; making your job more difficult so you will have to rely on your loan officer (mlo) to determine if the deal is “do-able”.
Here’s the basics:
401(k) Loan:
Borrowers must qualify with (re) payment of the 401k loan in conjunction with qualifying for mortgage.
Generally speaking an employee may only have one 401k loan at any given time, although there are exceptions & a current loan can be rolled into a new loan with a higher balance, for the purposes of getting a home loan.
Typically buyers may borrow up to 50% or $50,000 of their 401(k) funds for a down payment, whichever is less.
Borrower/buyers will be required to provide the lender with the terms of repayment (typically with an employer handbook).
Borrowing rates on 401(k) loans are set by the institution that administers the 401(k) which is chosen by the employer.
Typically its 1-2 percentage points above the current “prime rate” and typically amortized over 10 years.This is far more advisable than paying taxes and penalties for early IRA withdrawal.
The portion removed from the borrowers account is placed in an interest-bearing account.
So borrowers lose some, but not all of their ability to stay invested.
If a borrower leaves the employer administering the 401(k), they have 90 days to repay the remaining loan balance or if not, will receive a “1099” for the outstanding balance, and pay income tax on the money. And the possible penalties for “under withholding”.
Borrowers younger than 59 1/ 2 years are subject to 10% penalty for “early withdrawal”, if escrow doesn’t close in 60 days. Borrowers liquidating more than $10,000, 10% of the overage is withheld for taxes.
CRITICAL: A 401k from a former employer, must be rolled over into the new employer’s 401k plan to be eligible for a new loan.
Liquidating IRAs
Borrowers are allowed to take up to $10,000 penalty free for buying a first time home. Married couples are allowed up to $10,000 from each account (for a total of $20,000).
If borrowers liquidate more than $10,000, 20% of the overage will be withheld for taxes (the taxes will eventually be about 35% state and federal combined).
The definition of first time home buyer is a person who hasn’t owned a PRINCIPAL RESIDENCE over the past 3 years.
For example: Owning a rental property or vacation home doesn’t disqualify you from the 2 yr. rule.
NOTE: The home transaction must COE within 120 days of the withdrawal.
ROTH IRA WITHDRAWAL
Roth IRA contributions are made with after-tax dollars so you can withdraw your contributions at any time for down payment (or any other reason) with no tax liability.
But if a borrower withdraws any CAPITAL GAINS the ROTH ACCUMULATES beyond” cash contributions, there are more rules.
After the initial $10,000, withdrawals from capital gains are taxed as income and have a 10% penalty unless 2 things are true:
(1) The withdrawal occurs after five full “tax years.” A “tax year” begins January 1 of the contribution year, even if the contribution is made on December 31.
(2) A 1st-time buyer is someone who hasn’t owned a principal residence for 3 years.
A family member can help a spouse, child, or grandchild who is a first-time home buyer, and can make from Roth IRA withdrawal of up to $10,000 capital gains free, penalty-free.
SEP Retirement Plan
(Simplified Employee Pension)
For the sake of brevity click here for the IRS specifics of SEP plans.
SEP plans are basically an IRA with higher contribution limits.
Sole proprietors, partnerships, and corporations, including S corporations, can set up SEPs.
SEPS are eligible for a tax credit of up to $500 per year for each of the first 3 years for the cost of starting the plan.
The monies can be rolled over tax free into traditional IRA for the sake of a 1st time homeowner’s withdrawal.
The IRS website features handbooks with Q and A’s & it’s always best to talk with a licensed tax preparer before liquidating funds
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