You’ve finally found the home of your dreams. There’s just one thing standing between you, and your new house: The down payment.
Many home buyers today opt to use funds from their employer’s 401(K) program to come up with the down payment on a house. Ordinarily, you can’t take money from your 401(K) plan unless you retire, leave the company or become disabled. But many company plans permit certain “hardship withdrawals” when there is an immediate and heavy financial need, including the purchase of the employee’s principal residence.
The drawback to a hardship withdrawal is that you will pay taxes and penalties on the amount withdrawn from your plan. Often these taxes and penalties must be paid in the year of withdrawal. Even though hardship withdrawals are allowed by law, your employer is not required to provide them in your plan. Check with your employer’s human resources department if you’re not sure if your 401(K) plan allows hardship withdrawal.
Another approach may be to borrow against your 401(K) – sometimes as much as 85 percent of your account balance. You pay interest on the loan, but the interest goes back into your account. The money you receive is not taxable as long it is paid back, and plans can give you anywhere from 5 to 30 years to pay back your loan.
However, there are risks involved in borrowing from your 401(K). If you lose your job or leave your employer, you must pay back the loan in full within a short period, sometimes as little as 60 days. If the money is not paid back in that time, it is considered a withdrawal from your plan, and subjected to the same taxes and penalties. While 401(K) accounts can usually be rolled over into a new employer’s 401(K) without penalties, loans from a 401(K) cannot be rolled over.
Also, because the funds withdrawn from your account are no longer earning compound interest, your account will be smaller when you retire. In addition, you’ll be replacing pretax money with after-tax money which will further shrink your total amount.
If you are planning to use a loan towards a down payment for a home, be aware that this new “debt” might affect your chances to get approved. Some lenders will count the money you borrowed from your 401(K) as an additional debt that will go along with your car payments, student loans and credit cards. While it may seem unfair since you are borrowing your own money, most lenders view it as a payment obligation that affects your debt-to-income ratio in qualifying for a home loan. It may be a factor in whether you decide to make a hardship withdrawal from your 401(K) and pay tax penalties, or borrow against it.
Your 401(k) can be a useful asset when deciding where to draw your down payment from. However, it’s a financial decision that takes a bit of research, and careful consideration on your part. I recommend consulting with either your financial planner, or mortgage consultant. For more information regarding the home loan process, visit my website at www.AlissaAlvarez.com
When obtaining a loan for a home purchase, you will be dealing with lots of terms that relate to important numbers, and figures that will affect your loan approval. Before you get approved, it is vital that you understand these terms, and how they will impact your loan. We’ve already gone over what DTI is (see last entry), and now we will go over what Loan To Value, or LTV, means.
LTV: Loan to Value Ratio
Whether you are purchasing or refinancing a loan, the LTV will be used by the lender to determine loan approval. The LTV is the percentage that reflects the loan amount compared to the current market value of the property. The key element when determining the LTV is the amount the home appraises for. In some cases, a property can appraise for less than the sales price. In this case, the lender will require the loan amount, and the appraised amount to line up with one another. To calculate the LTV, you divide the appraisal amount by the loan amount after down payment.
Loan Amount / Appraised Amount = LTV
If you are purchasing, nowadays, almost every loan program requires a down payment. If you are going conventional, the down payment requirement can be anywhere from 5% to 30% of the purchase price. If you are using an FHA loan, you will need a minimum of 3.5% down payment. Let’s take a look at a few examples.
Scenario #1: FHA buyer putting 3.5% down
Appraised Amount: $350,000
Down Payment: $12,250
Loan Amount: $337,750
$337,750 / $350,000 = 96.5% LTV
Scenario #2: Conventional Buyer putting 20% down
Appraised Amount: $550,000
Down Payment: $110,000
Loan Amount: $440,000
$440,000 / $550,000 = 80% LTV
Again, the LTV is one of the most crucial terms to understand when obtaining a loan to purchase, or refinance a home. If you have more questions, do not hesitate to contact your mortgage professional! We loan officers love it when clients take an interest in their loan, and ask lots of questions!
If you have questions regarding a home loan, or how much you can be pre-approved for, visit my website at www.AlissaAlvarez.com