Saving for retirement is important for many Americans and many accomplish this through a 401k. But, another high ranking dream is buying a dream home. Whether it is a primary residence, vacation home, or rental property, a 401k loan may play a key role in buying a home. Not only is it a down payment source, there is also a key underwriting guidelines which helps borrowers qualify. Although, keep in mind that withdrawing or borrowing from a 401k may affect future returns or may be taxable. Therefore, always have a strategy session between a knowledgeable loan officer, your financial adviser, and/or your CPA. Let’s dig into how your 401k can make another dream come true!
Can I Use a 401k Loan for a Home Purchase?
Absolutely! Each home loan program has its own set of guidelines. Some require use of borrower’s own funds, where others may allow a gift, down payment assistance, a second mortgage, sale of an asset, or borrowing the down payment. An example of a restrictive program would be purchasing a rental property and that the down payment must be the borrower’s own funds. So, a gift would not work. But, “borrower own funds” does not mean only checking or savings account. Actually, it may come from many sources and one of those is a retirement account.
Although, the documentation requirements vary among mortgage guidelines, retirement funds are always allowed as a down payment source. Plus, it may come in the form of a distribution or a 401k loan. Either way, it is allowed.
Does a 401k Loan Affect My Debt to Income Ratio?
This is a very common question. Normally, loans of any type are counted as a debt which affects a home buyer’s qualification. Yet, there are some exceptions such as having just a few payments remaining on a loan. Some programs omit the debt if 6 payments remain, where others omit if there are 10 or less payments remaining. But, this is at the underwriter’s discretion too. But, one loan that does not hurt the debt to income ratio is a 401k loan. In essence, you are borrowing from yourself. So, borrowing from retirement does not hurt a buyer’s qualification.
Retirement Loan Tips
Foremost, it is key to fully understand the positives and negatives of taking out a 401k loan. As mentioned above, this involves a high level discussion to weigh out benefits vs potential setbacks. Additionally, here are some talking points to discuss with your financial team (CPA, financial adviser, loan officer).
- Start the withdrawal early
- Discuss affect on investment portfolio
- Weigh out home purchase vs retirement plan
- Determine if any income tax consequences (if liquidating retirement funds)
Furthermore, other similar sources for a home purchase down payment include…
- Life insurance cash value
- Liquidating or borrowing from…
- Mutual fund account
- Asset (not all programs allow a loan against a car or similar asset as down payment source)
- Sale of an asset (car, RV, stock, house, etc)
- Down payment assistance for primary residence purchase
- Home equity line or loan
- Gift funds (allow for primary or second home purchases only)
As usual, consult with your loan officer to determine if your down payment source matches the program guidelines.