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The drawback to a hardship withdrawal is that you will pay taxes and penalties on the amount withdrawn from your plan.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Also, because the funds withdrawn from your account are no longer earning compound interest, your account will be smaller when you retire.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
One of the first steps to purchasing a home is getting preapproved for a loan. Often, most borrowers get prequalified for a loan, which is a good start. However, in order to establish yourself to Realtors as a serious and able buyer, you will need a preapproval letter from a lender.
With a preapproval letter in hand, a buyer is now in position to do the following:
1. Save time by looking at the right properties. A preapproval letter will set your price range, thereby saving you from wasting time looking at homes out of your price range. Nothing is more disappointing than finding a home you fall in love with, going to a lender to apply for a loan only to find that you qualify for less than what you hoped for. Now, not only is the house out of reach, but homes in the lower price range can seem disappointing in comparison.
2. Increase your negotiating power. A seller’s highest priority is selling their home fast. Homes are like bread, the longer they stay on the shelf, the less desirable they become. Nobody likes stale bread! A buyer that is preapproved is more of a sure bet to close the transaction. Preapproved buyers will always have priority over prequalified buyers!
3. Faster closing period. If you are preapproved, the transaction will not be tied up while the application is being processed. Appraisals can be ordered, and the ball can get moving right away, which can decrease a closing period from 30 days to a couple of weeks! Again, this might be even more advantageous if a seller is in a bind, and needs to close quickly.
Completing a loan application is usually the most time consuming part of the transaction. If you have already taken care of this step, you are only positioning yourself ahead of the pack! If you would like to see how much you are pre-approved for, feel free to call me at (562) 972-0351, or visit my website at www.AlissaAlvarez.com