effenheimer_IHB
New member
Do lenders typically permit 401k funds to be counted as cash reserves for loan qualification purposes?
401k as cash reserves?
- Thread starter effenheimer_IHB
- Start date
NEW -> Contingent Buyer Assistance Program
graphrix_IHB
New member
Yes but they reduce it to 75% of what is worth. $100k in 401k = $75k that the lender will count.
effenheimer_IHB
New member
Thanks. I was reading another sob-story news article where some potential FB was locked out of the housing market at the 11th hour due to a lack of cash reserves.
IrvineRenter_IHB
New member
They will be writing that lender a thank you card 3 years from now.
crucialtaunt_IHB
New member
<p>OC- I cannot believe you even asked the question!?? Why would anyone in their right minds even reveal to a lender what is in their <em>pre-tax retirement</em> savings account? </p>
<p>Slightly off topic, but since you opened the proverbial pandora's box on 401(k)s, here are some facts to consider about them:</p>
Pre-tax employee deferrals cannot be taken out of the plan unless there is a distributable event such as retirement, death, or termination from service, and are subject to a 10% additional early withdrawal penalty if taken out before age 59 1/2 (on <em>top</em> of taxes due at the tax rate on your AGI for the year of distribution, with some exceptionss).
Some company plans allow for "hardship withdrawals" because of immediate and heavy financial needs, such as (generally) medical expenses, college level tuition, purchase of principal residence, payments to prevent eviction or foreclosure on primary home, funeral expenses, or repairs to principal residence due to casualty loss such as to a hurricane or flooding (think Katrina etc.). The 10% penalty applies here too if you are under age 59 1/2. Some exceptions to the tax are available but not for housing realted reasons. People often confuse this with IRA withdrawal rules - which allow for a one-time penalty-free (not tax-free) withdrawal up to $10,000 (each spouse, possibly) for a first-time home purchase. No payback or rollover options are available! In other words, you would permanently deplete your retirement account if you went this route.
Some plans allow for loans, and some even allow for home purchase loans. The total amount of all loans cannot exceed the lesser of $50,000 or 50% of your vested account balance.
General purpose (no reason given) loans are for 5 years, and interest rates are set by the plan, generally prime plus or minus 1%.
If a plan allows home purchase loans, they can be amortized over a period longer than 5 years. Some plans allow 10- or 15- year payback periods for such loans. Some documentation is required.
Generally you are paying interest back to your own account.
Fees vary with provider, but generally expect to pay $50-$100 or so to originate, and $50 - $100 per year in annual maintenance fees.
If loans are not paid back within the set time period, the outstanding amount plus any accrued interest becomes a taxable event and you will get a 1099 in the mail and have to include the amount as income for the year (and pay 10% penalty if you are under age 59 1/2).
>
>
<p>I would strongly recommend against (1) disclosing your retirement accounts to loan agents, (2) taking out hardship withdrawals for home purchase - unless you have a true hardship, i.e. casualty loss, <em>a la</em> Hurricane Katrina. If you must touch your retirement account for helping with a home purchase, use the loan feature since you are paying yourself back the interest (less maintenance fees).</p>
<p>Slightly off topic, but since you opened the proverbial pandora's box on 401(k)s, here are some facts to consider about them:</p>
Pre-tax employee deferrals cannot be taken out of the plan unless there is a distributable event such as retirement, death, or termination from service, and are subject to a 10% additional early withdrawal penalty if taken out before age 59 1/2 (on <em>top</em> of taxes due at the tax rate on your AGI for the year of distribution, with some exceptionss).
Some company plans allow for "hardship withdrawals" because of immediate and heavy financial needs, such as (generally) medical expenses, college level tuition, purchase of principal residence, payments to prevent eviction or foreclosure on primary home, funeral expenses, or repairs to principal residence due to casualty loss such as to a hurricane or flooding (think Katrina etc.). The 10% penalty applies here too if you are under age 59 1/2. Some exceptions to the tax are available but not for housing realted reasons. People often confuse this with IRA withdrawal rules - which allow for a one-time penalty-free (not tax-free) withdrawal up to $10,000 (each spouse, possibly) for a first-time home purchase. No payback or rollover options are available! In other words, you would permanently deplete your retirement account if you went this route.
Some plans allow for loans, and some even allow for home purchase loans. The total amount of all loans cannot exceed the lesser of $50,000 or 50% of your vested account balance.
General purpose (no reason given) loans are for 5 years, and interest rates are set by the plan, generally prime plus or minus 1%.
If a plan allows home purchase loans, they can be amortized over a period longer than 5 years. Some plans allow 10- or 15- year payback periods for such loans. Some documentation is required.
Generally you are paying interest back to your own account.
Fees vary with provider, but generally expect to pay $50-$100 or so to originate, and $50 - $100 per year in annual maintenance fees.
If loans are not paid back within the set time period, the outstanding amount plus any accrued interest becomes a taxable event and you will get a 1099 in the mail and have to include the amount as income for the year (and pay 10% penalty if you are under age 59 1/2).
>
>
<p>I would strongly recommend against (1) disclosing your retirement accounts to loan agents, (2) taking out hardship withdrawals for home purchase - unless you have a true hardship, i.e. casualty loss, <em>a la</em> Hurricane Katrina. If you must touch your retirement account for helping with a home purchase, use the loan feature since you are paying yourself back the interest (less maintenance fees).</p>
<p>If you take a loan against your 401k, you will be paying it back (to yourself) with interest using after-tax dollars. You will then pay tax on that money again when you withdraw it during your retirement. Because of this double taxation issue, a 401k is generally not the best place to look for down payment funds. If your intent is to save up for a down payment, you're generally better off keeping your money in the bank rather than plopping it into a 401k and then borrowing against it later.</p>
<p>That point was lost on me until recently, when someone explained it to me. Do you agree with that advice crucialtaunt and others?</p>
<p>That point was lost on me until recently, when someone explained it to me. Do you agree with that advice crucialtaunt and others?</p>
crucialtaunt_IHB
New member
<p>reid: 100% agreed with you on this issue of double taxation. The only <em>minor</em> point on the "other side of the column" would be that the amount of taxes you lose due to double taxation would potentially be small compared to the tax deferred earnings gains you may have on your account in your investments.</p>
<p>Regardless, you are correct in that, this is one more reason not to touch your 401(k) for home purchase. However, if you had to do it, then pick the lesser of the evils, i.e. loans allow you to replenish your retirement savings whereas the other withdrawal option does not.</p>
<p>Regardless, you are correct in that, this is one more reason not to touch your 401(k) for home purchase. However, if you had to do it, then pick the lesser of the evils, i.e. loans allow you to replenish your retirement savings whereas the other withdrawal option does not.</p>
IrvineRenter_IHB
New member
I don't know if I agree with you guys about the 401K borrowing for a home.
If you have to borrow from someplace (you don't have the cash), you will be paying back a loan with after-tax dollars regardless. Therefore, whether you are paying back your 401K or some other lender, you still paying taxes on your payments.
If you borrow money from your 401K, you are making the interest as you are paying yourself. I don't believe you are taxed on this interest income because it is your 401K that is making the money. Unless you know you can make a higher return than you are charging yourself through your 401K loan, you are no worse off by borrowing this money.
If you have to borrow from someplace (you don't have the cash), you will be paying back a loan with after-tax dollars regardless. Therefore, whether you are paying back your 401K or some other lender, you still paying taxes on your payments.
If you borrow money from your 401K, you are making the interest as you are paying yourself. I don't believe you are taxed on this interest income because it is your 401K that is making the money. Unless you know you can make a higher return than you are charging yourself through your 401K loan, you are no worse off by borrowing this money.
crucialtaunt_IHB
New member
<p>Great points all. Best to leave the 401(k) out of it though...</p>
<p class="MsoNormal">Let's throw some numbers out there... Let’s say you and your spouse take out identical $50k loans each from your 401(k)s, for a total of $100k. At 7% interest and 30 year term, the loan would look like this:</p>
<p class="MsoNormal"><strong style="mso-bidi-font-weight: normal">Loan summary </strong></p>
<p class="MsoNormal">Monthly payment $665.30 </p>
<p class="MsoNormal">Loan amount $100,000 </p>
<p class="MsoNormal">Interest rate 7.000% </p>
<p class="MsoNormal">Term 360 months </p>
<p class="MsoNormal">Total of payments $239,510.98 </p>
<p class="MsoNormal">Total interest paid $139,510.98 </p>
<p class="MsoNormal">Reinvested back in your plan, the loan payments would grow to $1.1 million in 30 years.</p>
<p class="MsoNormal"><strong style="mso-bidi-font-weight: normal">Loan Payments at Reinvestment</strong></p>
<p class="MsoNormal">Your 401(k) loan payments: $7,980.00 per year ($665 x 12)</p>
<p class="MsoNormal">Average Annual Return: 9% </p>
<p class="MsoNormal">Holding Period: 30 Years </p>
<p class="MsoNormal">Total you will contribute: $239,400.00 </p>
<p class="MsoNormal">Total in 30 Years: $1,140,063 </p>
<p class="MsoNormal">However, the counter point is, if you leave your $100k principal in the 401(k) without taking it out for a loan, with the same average annual growth rate of 9%:</p>
<p class="MsoNormal"><strong style="mso-bidi-font-weight: normal">No Loan – Just keep the $100k invested</strong></p>
<p class="MsoNormal">Current 401(k) balance: $100,000</p>
<p class="MsoNormal">Years to invest: 30 </p>
<p class="MsoNormal">Annual rate of return: 9.00% </p>
<p class="MsoNormal">Total in 30 Years: $1,326,768 </p>
<p class="MsoNormal"><strong>You come out ahead by almost $200,000. So it does make sense to leave things in and not touch your 401(k) at all.</strong></p>
<p class="MsoNormal">Now compare either of these two scenarios against the amounts you would be paying in interest to a bank (i.e. no return to you). With tax-deduction on the $140k interest, the net interest cost to you would be around $101k. But you would have lost an additional $1.1 million in growth in your 401(k).</p>
<p class="MsoNormal">Let's throw some numbers out there... Let’s say you and your spouse take out identical $50k loans each from your 401(k)s, for a total of $100k. At 7% interest and 30 year term, the loan would look like this:</p>
<p class="MsoNormal"><strong style="mso-bidi-font-weight: normal">Loan summary </strong></p>
<p class="MsoNormal">Monthly payment $665.30 </p>
<p class="MsoNormal">Loan amount $100,000 </p>
<p class="MsoNormal">Interest rate 7.000% </p>
<p class="MsoNormal">Term 360 months </p>
<p class="MsoNormal">Total of payments $239,510.98 </p>
<p class="MsoNormal">Total interest paid $139,510.98 </p>
<p class="MsoNormal">Reinvested back in your plan, the loan payments would grow to $1.1 million in 30 years.</p>
<p class="MsoNormal"><strong style="mso-bidi-font-weight: normal">Loan Payments at Reinvestment</strong></p>
<p class="MsoNormal">Your 401(k) loan payments: $7,980.00 per year ($665 x 12)</p>
<p class="MsoNormal">Average Annual Return: 9% </p>
<p class="MsoNormal">Holding Period: 30 Years </p>
<p class="MsoNormal">Total you will contribute: $239,400.00 </p>
<p class="MsoNormal">Total in 30 Years: $1,140,063 </p>
<p class="MsoNormal">However, the counter point is, if you leave your $100k principal in the 401(k) without taking it out for a loan, with the same average annual growth rate of 9%:</p>
<p class="MsoNormal"><strong style="mso-bidi-font-weight: normal">No Loan – Just keep the $100k invested</strong></p>
<p class="MsoNormal">Current 401(k) balance: $100,000</p>
<p class="MsoNormal">Years to invest: 30 </p>
<p class="MsoNormal">Annual rate of return: 9.00% </p>
<p class="MsoNormal">Total in 30 Years: $1,326,768 </p>
<p class="MsoNormal"><strong>You come out ahead by almost $200,000. So it does make sense to leave things in and not touch your 401(k) at all.</strong></p>
<p class="MsoNormal">Now compare either of these two scenarios against the amounts you would be paying in interest to a bank (i.e. no return to you). With tax-deduction on the $140k interest, the net interest cost to you would be around $101k. But you would have lost an additional $1.1 million in growth in your 401(k).</p>
momopi_IHB
New member
Generally speaking, I don't recommend borrowing against or cashing out of your retirement to buy a house.
Back in late 1990's to early 2000's, it might've made sense to jump in a rapidly apperciating RE market by whatever means. But not today.
I recall in 1998-1999, my buddy bought a brand new 3 bed townhome for $250k. His salary was less than $40k/year, so he had to scrimp funds from every source to afford it, including retirement, borrow from his sister, co-sign with his mother, and eat lots of maruchan ramen. We drove by the maruchan factory in Irvine and I thought, how ironic, you had to eat instant ramen to afford a house here and the noodle factory is right here. Had he waited, he wouldn't have been able to afford to buy it because the value climbed to $700k+ in 2005.
Back in late 1990's to early 2000's, it might've made sense to jump in a rapidly apperciating RE market by whatever means. But not today.
I recall in 1998-1999, my buddy bought a brand new 3 bed townhome for $250k. His salary was less than $40k/year, so he had to scrimp funds from every source to afford it, including retirement, borrow from his sister, co-sign with his mother, and eat lots of maruchan ramen. We drove by the maruchan factory in Irvine and I thought, how ironic, you had to eat instant ramen to afford a house here and the noodle factory is right here. Had he waited, he wouldn't have been able to afford to buy it because the value climbed to $700k+ in 2005.
IrvineRenter_IHB
New member
momopi,
When I first read your story, I read 1989 instead of 1999. If your friend had purchased a $250K home in 1989, he would have been struggling to make the payments on a house while he was underwater for 10 years. He was certainly more fortunate to do this in 1999. Personally, I will rent forever rather than pay 6 times income for a house, but that is me.
When I first read your story, I read 1989 instead of 1999. If your friend had purchased a $250K home in 1989, he would have been struggling to make the payments on a house while he was underwater for 10 years. He was certainly more fortunate to do this in 1999. Personally, I will rent forever rather than pay 6 times income for a house, but that is me.
IrvineRenter_IHB
New member
crucialtaunt,
The calculation depends entirely on the difference between the interest rate on the loan you earn, and the rate of return you give up. Personally, I don't think I would borrow from a 401K to finance a home, but if other investments were doing poorly, it may be the better way to go.
The calculation depends entirely on the difference between the interest rate on the loan you earn, and the rate of return you give up. Personally, I don't think I would borrow from a 401K to finance a home, but if other investments were doing poorly, it may be the better way to go.
momopi_IHB
New member
Hello IrvineRenter,
It was a huge financial risk at the time, both of us were just out of college and working at our first "real job". Fortunately the gamble paid off for him.
Back then I thought Irvine was way over-priced. For example in Buena Park you could've bought an older single family home w/yard for $180k, I thought who would want to pay $250k for a townhouse?? For the price of a 1 bed condo at Oak Park/Oak Creek, you could've bought a new 2 bed condo in Placentia @ Altura for $10k more and rent to CSUF students with small positive cash flow. In Irvine I couldn't break even after paying HOA fees at the time.
...then my company announced that we were moving to Irvine in "a few years", and the rest is history.
It was a huge financial risk at the time, both of us were just out of college and working at our first "real job". Fortunately the gamble paid off for him.
Back then I thought Irvine was way over-priced. For example in Buena Park you could've bought an older single family home w/yard for $180k, I thought who would want to pay $250k for a townhouse?? For the price of a 1 bed condo at Oak Park/Oak Creek, you could've bought a new 2 bed condo in Placentia @ Altura for $10k more and rent to CSUF students with small positive cash flow. In Irvine I couldn't break even after paying HOA fees at the time.
...then my company announced that we were moving to Irvine in "a few years", and the rest is history.
effenheimer_IHB
New member
<p>Interesting discussion... Crucial, two questions... First, what's wrong with revealing retirement acct funds to a loan officer? Second, I wonder how the numbers would shake-out if current loan pricing trends continue and a 401k loan would get you to down to 80% LTV. I think 401k loans are [generally] a bad idea but I can see a day where LTV's over 80% are gonna really sock it to you on interest rates. I would suspect that in a true credit crunch, the 401k loan might be a worthwhile sacrifice. Your thoughts?</p>
IrvineRenter_IHB
New member
oc_fliptrack,
I am going to take a real look at borrowing from my 401K when the time comes. Depending on how much prices drop, and where I have my money parked, I may not want to put that much of my liquid net worth into a down payment.
If you know you are going to save for 3 to 5 years for a downpayment, you can save the money after-tax or before-tax. If you save it before tax, you will save more, plus you won't be taxed on the growth over that time. Even if you are limited to borrowing 50% of that money, I think you come out ahead.
Note I am assuming you change your 401K withholding to increase savings during this time. I am not advocating changing your retirement planning by borrowing against funds that are spoken for. Unless you are already maxed out on your 401K withholding (which I remember you saying you were), you have the option of diverting the money you were going to save for the house into your 401K and borrow it later. The advantage of this approach also is that you end up with more for retirement and you pay yourself interest.
Here is the math:
After tax savings: $10,000 * 0.6 = $6,000 + (interest @ 5% reduced 30% for taxes) $210 = $6,210 saved for the house.
Before tax savings: $10,000 + (interest @ 5%) $500 = 10,500 / (borrowing limitation) 2 = $5,250 saved for the house.
After 5 years of interest compounding, you have $33,300 saved after-tax, or $29,009.56 available to borrow from your retirement plan. <em>However, you are also $29,009 farther ahead in your retirement plan.</em>
Something to think about.
I am going to take a real look at borrowing from my 401K when the time comes. Depending on how much prices drop, and where I have my money parked, I may not want to put that much of my liquid net worth into a down payment.
If you know you are going to save for 3 to 5 years for a downpayment, you can save the money after-tax or before-tax. If you save it before tax, you will save more, plus you won't be taxed on the growth over that time. Even if you are limited to borrowing 50% of that money, I think you come out ahead.
Note I am assuming you change your 401K withholding to increase savings during this time. I am not advocating changing your retirement planning by borrowing against funds that are spoken for. Unless you are already maxed out on your 401K withholding (which I remember you saying you were), you have the option of diverting the money you were going to save for the house into your 401K and borrow it later. The advantage of this approach also is that you end up with more for retirement and you pay yourself interest.
Here is the math:
After tax savings: $10,000 * 0.6 = $6,000 + (interest @ 5% reduced 30% for taxes) $210 = $6,210 saved for the house.
Before tax savings: $10,000 + (interest @ 5%) $500 = 10,500 / (borrowing limitation) 2 = $5,250 saved for the house.
After 5 years of interest compounding, you have $33,300 saved after-tax, or $29,009.56 available to borrow from your retirement plan. <em>However, you are also $29,009 farther ahead in your retirement plan.</em>
Something to think about.
IrvineRenter_IHB
New member
$10,000.00 $10,000.00
1 $6,000.00 $210.00 $6,210.00 $10,000.00 $500.00 $10,500.00
2 $12,210.00 $427.35 $12,637.35 $20,500.00 $1,025.00 $21,525.00
3 $18,637.35 $652.31 $19,289.66 $31,525.00 $1,576.25 $33,101.25
4 $25,289.66 $885.14 $26,174.80 $43,101.25 $2,155.06 $45,256.31
5 $32,174.80 $1,126.12 $33,300.91 $55,256.31 $2,762.82 $58,019.13
$33,300.91 $29,009.56
1 $6,000.00 $210.00 $6,210.00 $10,000.00 $500.00 $10,500.00
2 $12,210.00 $427.35 $12,637.35 $20,500.00 $1,025.00 $21,525.00
3 $18,637.35 $652.31 $19,289.66 $31,525.00 $1,576.25 $33,101.25
4 $25,289.66 $885.14 $26,174.80 $43,101.25 $2,155.06 $45,256.31
5 $32,174.80 $1,126.12 $33,300.91 $55,256.31 $2,762.82 $58,019.13
$33,300.91 $29,009.56
effenheimer_IHB
New member
<p>There's one other aspect to consider... If I and my employer part ways, the 401k loan must be repaid with 60(?) days. I'm sure I could scrape 20-30k together in 60 days but I don't know about 50-75k. I'm not confident that I'd be able to get a HELOC to help pay-off the 401k loan if my home equity position were only ~20%. Today this might be do-able, but I wouldn't count on it three years from now.</p>
<p>This is why I cut back my 401k contribs this year. The taxes are eating me alive but I fear that I'd be 401k-rich and cash-poor when I'm finally ready to buy.</p>
<p>This is why I cut back my 401k contribs this year. The taxes are eating me alive but I fear that I'd be 401k-rich and cash-poor when I'm finally ready to buy.</p>
IrvineRenter_IHB
New member
oc_fliptrack,
Yeah, that is an issue. That was why I said it depends on where I have my money parked. All the eggs in one basket is an issue.
You could always withdrawl the money and pay the taxes and penalties if you change jobs. Also, if you change jobs, you could roll over your 401K to a self-directed IRA or 401K with a custodian like <a href="http://www.sterling-trust.com/">Sterling Trust</a>. Then you are the administrator of your own loan.
Another option to consider is putting money into a Roth IRA if you are eligible. You can withdrawal all the contributions tax-free (you have already been taxed on this money once). You don't get any advantage of any of the interest, but you get to keep this interest in a tax-free retirement account. Every little bit helps.
Yeah, that is an issue. That was why I said it depends on where I have my money parked. All the eggs in one basket is an issue.
You could always withdrawl the money and pay the taxes and penalties if you change jobs. Also, if you change jobs, you could roll over your 401K to a self-directed IRA or 401K with a custodian like <a href="http://www.sterling-trust.com/">Sterling Trust</a>. Then you are the administrator of your own loan.
Another option to consider is putting money into a Roth IRA if you are eligible. You can withdrawal all the contributions tax-free (you have already been taxed on this money once). You don't get any advantage of any of the interest, but you get to keep this interest in a tax-free retirement account. Every little bit helps.
crucialtaunt_IHB
New member
<p>OC_Fliptrack: <em>"Crucial, two questions... First, what's wrong with revealing retirement acct funds to a loan officer? Second, I wonder how the numbers would shake-out if current loan pricing trends continue and a 401k loan would get you to down to 80% LTV."</em></p>
<p>First question: it's just my personal opinion - I don't think tax-deferred accounts meant for retirement purposes should be use to secure approval on mortgages. One should ideally have "enough" assets outside of tax-deferred plans to show for mortgage qualification purposes. If one does not, then he/she should consider renting a little while longer, and build enough after-tax assets to show a loan officer.</p>
<p>(Caveat: If it helps you get a better rate on the mortgage for example if you have credit record issues, then definitely pull it out if it helps you get a lower payment or better terms overall.)</p>
<p>Either way, it is a well known fact that 401(k) assets cannot be attached in case of a bankruptcy (ERISA exemption). So even if you show 401(k) assets for qualification purposes, they really cannot be sought after by a lender when/if pursuing assets at BK. However, I know of at least one situation where someone was "gently urged" by the bank (illegally) in a BK case to take a 401(k) hardship withdrawal to payback a delinquent bank loan.</p>
<p>First question: it's just my personal opinion - I don't think tax-deferred accounts meant for retirement purposes should be use to secure approval on mortgages. One should ideally have "enough" assets outside of tax-deferred plans to show for mortgage qualification purposes. If one does not, then he/she should consider renting a little while longer, and build enough after-tax assets to show a loan officer.</p>
<p>(Caveat: If it helps you get a better rate on the mortgage for example if you have credit record issues, then definitely pull it out if it helps you get a lower payment or better terms overall.)</p>
<p>Either way, it is a well known fact that 401(k) assets cannot be attached in case of a bankruptcy (ERISA exemption). So even if you show 401(k) assets for qualification purposes, they really cannot be sought after by a lender when/if pursuing assets at BK. However, I know of at least one situation where someone was "gently urged" by the bank (illegally) in a BK case to take a 401(k) hardship withdrawal to payback a delinquent bank loan.</p>
graphrix_IHB
New member
Just a note on 401k info. If you leave your company you don't always have to roll it over. When I left my last company my 401k was and still is with Fidelity and I didn't want to roll it over because a chunk of my money is in a fund that is closed to new investors and it is a top performer. As long as I had $10k in there they let you keep it.