A Quick Review Of The 401 Rules
A 401 account is earmarked to save for retirementthat’s why account holders get the tax breaks. In return for giving a deduction on the money contributed to the plan and for letting that money grow tax-free, the government severely limits account holders’ access to the funds.
Not until you turn 59½ are you supposed to withdraw fundsor age 55, if you’ve left or lost your job. If neither is the case, and you do take money out, you incur a 10% early withdrawal penalty on the sum withdrawn. To add insult to injury, account holders also owe regular income tax on the amount .
Still, it is your money, and you’ve got a right to it. If you want to use the funds to buy a house, you have two options: borrow from your 401 or withdraw the money from your 401.
If You Default On Your 401 Loan You’ll Owe A Penalty
If you do not pay your 401 loan back as required, the defaulted loan is considered a withdrawal or distribution and thus subject to a 10% penalty applicable to early withdrawals made before age 59 1/2. That’s potentially a huge cost, especially when you also consider the loss of the potential gains your money would have made had you left it invested.
The penalty for defaulted loans still applies to COVID-19 related loans taken under the CARES Act’s special rules applicable in 2020. This can be confusing, as the CARES Act also altered the rules for withdrawals, enabling you to take a coronavirus-related distribution from your 401 in 2020 without incurring the customary 10% tax penalty. Unfortunately, if you default on your 401 loan, it doesn’t convert to a penalty-free withdrawal, even if you would have been entitled to one in 2020.
Should I Refinance If Interest Rates Are Low
When interest rates fall, the possibility of getting a lower mortgage rate is a strong reason to consider refinancing if you need additional funds. A reduction in your mortgage rate could lead to significantly lower monthly payments.
However, you must factor in the costs of ending your current mortgage, including any prepayment charges, as well as how long you expect to live in your home. Only then can you determine whether its worthwhile to refinance at a lower rate.
Recommended Reading: How To Pull Out Of 401k
Borrow Against Your 401
Borrowing from your 401 is generally the more advantageous option if you want to tap your plan for a down payment.
If your employers plan allows employees to take out loans against their 401 accounts, youll typically be able to borrow up to 50% of your vested account balance or $50,000, whichever is less.
Tip:
Youll then have to make more or less equal payments at least quarterly, with interest until youve repaid the loan. Youll typically need to repay it within five years.
Upsides
- Wont affect your credit
Downsides
Learn More: 401 Loans: Should You Borrow Against Your Retirement?
Is It A Good Idea To Borrow From Your 401
Using a 401 loan for elective expenses like entertainment or gifts isn’t a healthy habit. In most cases, it would be better to leave your retirement savings fully invested and find another source of cash.
On the flip side of what’s been discussed so far, borrowing from your 401 might be beneficial long-termand could even help your overall finances. For example, using a 401 loan to pay off high-interest debt, like credit cards, could reduce the amount you pay in interest to lenders. What’s more, 401 loans don’t require a credit check, and they don’t show up as debt on your credit report.
Another potentially positive way to use a 401 loan is to fund major home improvement projects that raise the value of your property enough to offset the fact that you are paying the loan back with after-tax money, as well as any foregone retirement savings.
If you decide a 401 loan is right for you, here are some helpful tips:
- Pay it off on time and in full
- Avoid borrowing more than you need or too many times
- Continue saving for retirement
It might be tempting to reduce or pause your contributions while you’re paying off your loan, but keeping up with your regular contributions is essential to keeping your retirement strategy on track.
Long-term impact of taking $15,000 from a $38,000 account balance
Read Also: Can You Transfer Your 401k
Requirements To Refinance A Mortgage For Cash
Youll typically need more equity to do a cash-out refinance. Mortgage guidelines require a home appraisal in most cases. Theres one exception: You might get an appraisal waiver if you leave 30% equity in your home after taking cash out. Be prepared for interest-rate sticker shock, though, because cash-out refinance loans typically have higher fees and rates.
Refinancing your home with government-backed, cash-out refinance loans gives you more qualifying flexibility. In the case of VA loans, that translates to more borrowing power.
What Happens If You Use Your 401 To Buy A House
Your 401 might be your largest asset, making it a tempting source of funds for your down payment but going this route isnt usually recommended.
Amy FontinelleUpdated June 2, 2021
Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.”
Saving up for a down payment can be a major hurdle to homeownership, especially since it isnt the only expense in the mortgage process. You might need to come up with money for closing costs, moving costs, and modifications or furnishings for your new home as well.
If youre short on cash, one way you can fund your down payment is to draw from your 401. However, this comes with significant drawbacks.
Heres what you need to know about using your 401 for a home down payment:
Recommended Reading: How To Collect Your 401k From Previous Employer
How To Use A 401 For A Home Down Payment
Buying a home is a significant part of the American Dream. But saving enough money for a down payment is usually the biggest obstacle for first-time homebuyers.
According to the National Association of Realtors, the average down payment on a home is around 11% of the purchase price. This translates to $33,000 on a $300,000 mortgage.
Eleven percent can add up to a significant amount of money. Plus, you will usually have to pay 25% for closing costs. The amount you put down will help determine your monthly payments, so it’s an important factor for homebuyers.
One method that some people use to finance their down payments is to tap into retirement accounts, such as a 401. There are two ways to use a 401 to finance a home purchase: borrow from it and withdraw money from it.
Here are the pros and cons of these two options.
Loans To Purchase A Home
Regulations require 401 plan loans to be repaid on an amortizing basis over not more than five years unless the loan is used to purchase a primary residence. Longer payback periods are allowed for these particular loans. The IRS doesn’t specify how long, though, so it’s something to work out with your plan administrator. And ask whether you get an extra year because of the CARES bill.
Also, remember that CARES extended the amount participants can borrow from their plans to $100,000. Previously, the maximum amount that participants may borrow from their plan is 50% of the vested account balance or $50,000, whichever is less. If the vested account balance is less than $10,000, you can still borrow up to $10,000.
Borrowing from a 401 to completely finance a residential purchase may not be as attractive as taking out a mortgage loan. Plan loans do not offer tax deductions for interest payments, as do most types of mortgages. And, while withdrawing and repaying within five years is fine in the usual scheme of 401 things, the impact on your retirement progress for a loan that has to be paid back over many years can be significant.
If you do need a sizable sum to purchase a house and want to use 401 funds, you might consider a hardship withdrawal instead of, or in addition to, the loan. But you will owe income tax on the withdrawal and, if the amount is more than $10,000, a 10% penalty as well.
Read Also: Can I Move My 401k To A Different Company
Borrowing Against A : What To Consider
Sarah Brodsky
Ideally, money that you put into a 401 is supposed to stay there until you retire. The IRS imposes a number of restrictions and penalties on early distributions that are meant to dissuade people from pulling their funds out early. Still, the government recognizes that there are times when it’s appropriate to tap into that money, and it allows you to borrow from a 401 with some limitations.
Should You Get A 401 Loan
Whether a 401 loan is the right for you depends on your situation. For some borrowers, especially those with poor credit, a 401 loan can help you avoid high-interest debt. As long as you can afford to repay the loan, its generally better to be paying interest to yourself than to someone else.
But 401 loans arent without risks, the greatest being that if you cant afford to repay the loan or leave your job early, you may have your loan converted to an early withdrawal. These carry the same possible 10% penalty and tax consequences as any other early withdrawal from a 401.
Youre also potentially missing out on up to five years of investment gains, depending on the length of your 401 loan. Remember that over the long term, the S& P 500 has gained an average of about 10% every year. While you could get lucky and make your 401 loan during an extended dip or recession, the longer your money is out, the more growth you may miss.
Before taking a loan from your 401, be sure to consider all other options, like emergency funds, taxable investment accounts, low-cost loans from personal lenders, HELOCs if you have home equity or any 0% APR credit cards you may be eligible for. While a 401 loan can make sense in some circumstances, its not the best choice for everyone.
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Super: TD presents Asking for a FriendWhy Would You Refinance?
Welcome to Asking for a Friend. Lets see who could use some financial advice today.
Dear Asking for a Friend,My neighbour was talking about refinancing her home so she can borrow more money to build an extension, and it got me wondering…what exactly IS refinancing and why do people refinance?Sincerely,Next Door Nancy
I hear you, Nancy. First, what is refinancing?
Refinancing means renegotiating your existing mortgage loan agreement, usually to use any available equity in your home.
So what does that mean in real terms? Let’s say the value of your home is $500,000.
Super: $500,000
80% of home value 0.8 x $500,000 $400,000Outstanding balance of your mortgage $300,000How much you can borrow $100,000
Subject to the bank’s approval, you could borrow up to 80% of the value of your home less the outstanding balance of your mortgage.
That means if your home is worth $500,000 and you have an outstanding balance of $300,000 on your mortgage, you may be able to borrow an additional $100,000 .
So WHY do people refinance?
Super: To consolidate debts.
Super: Provide flexibility to pay for big ticket items.
Book an appointment and get financial advice for what you feel is most essential, through TD Ready Advice
Endslate: Visit td.com/readyadvice
House Hacking With Your 401k
Good news! You can! Despite what I said above, you can still use your 401k to house hack. Just not directly.
How?
You can give yourself a loan from your 401k for the lesser of $50,000 or 50% of your 401ks balance. This can help with your down payment on a house hack.
You will be paying your solo 401k interest of approximately 4.0%. This is certainly not the best use of your 401k money, but if you do not care much about the balance of your 401k and are looking to invest in real estate to achieve early financial freedom, this may make sense.
So, rather than going ahead and liquidating the 401k, use it to your advantage. The net proceeds you would get when taking it out and when taking a loan against it are almost equivalent. Still, by taking a loan against it, you are not getting penalized and your 401k is still growing tax-free.
Warning! Before making the loan request, be sure to talk to your lender. Taking a loan out against your 401k does reduce the amount of your reserves and therefore may impact your ability to get financing.
Recommended Reading: How To Pull Money From 401k
What Are The Differences In The Loan Rules For Amounts Borrowed By Participants After Hurricanes Harvey Irma And Maria
For participants affected by Hurricanes Harvey, Irma, or Maria, the maximum amount that can be borrowed from August 23, 2017 , September 4, 2017 , or September 16, 2017 , through December 31, 2018, from a plan is generally increased to the lesser of $100,000 or 100% of the participants account balance. In addition, repayments due from affected individuals may be suspended by the plan for one year.
What Are Some Alternatives To A 401 Loan
When cash is tight, borrowing from your 401 plan and paying yourself interest may seem like a good idea. But before you borrow, weigh all your options. Here are a few.
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Is A Deemed Distribution Treated Like An Actual Distribution For All Purposes
No, a deemed distribution is treated as an actual distribution for purposes of determining the tax on the distribution, including any early distribution tax. A deemed distribution is not treated as an actual distribution for purposes of determining whether a plan satisfies the restrictions on in-service distributions applicable to certain plans. In addition, a deemed distribution is not eligible to be rolled over into an eligible retirement plan. -1, Q& A-11 and -12)
Borrowing From Your Ira
An individual retirement account, or an IRA, is also a source for cash needed to close. You can borrow up to $10,000 from a traditional IRA, or $20,000 for a married couple. As long as you pay the funds back within 120 days, the disbursement is tax and penalty-free. If this is your first home, you can use the funds from an IRA and not have to pay any taxes or early withdrawal penalty. Obtaining a loan from an IRA is really less of a loan but instead a temporary withdrawal.
There are minor differences between a traditional and a Roth IRA. With a Roth, withdrawals are not subject to income tax or early withdrawal penalties by the IRS.
Read Also: How Do You Get Money From Your 401k
How Long After Applying For A Loan Can I Expect To Receive The Money
- For Electronic Funds Transfer : generally within two business days if all required documentation has been received in good order and your loan request has been approved
- Retirement Plan Loan prepayments are accepted in increments of the scheduled repayment amount
- Collateralized Loan prepayments are accepted if equal to or greater than the scheduled repayment amount
Other Alternatives To A 401 Loan
Borrowing from yourself may be a simple option, but its probably not your only option. Here are a few other places to find money.
Use your savings. Your emergency cash or other savings can be crucial right now and why you have emergency savings in the first place. Always try to find the best rate on an online savings account so that youre earning the highest amount on your funds.
Take out a personal loan. Personal loan terms could be easier for you to repay without having to jeopardize your retirement funds. Depending on your lender, you can get your money within a day or so. 401 loans might not be as immediate.
Try a HELOC. A home equity line of credit, or HELOC, is a good option if you own your home and have enough equity to borrow against. You can take out what you need, when you need it, up to the limit youre approved for. As revolving credit, its similar to a credit card and the cash is there when you need it.
Get a home equity loan. This type of loan can usually get you a lower interest rate, but keep in mind that your home is used as collateral. This is an installment loan, not revolving credit like a HELOC, so its good if you know exactly how much you need and what it will be used for. While easier to get, make sure you can pay this loan back or risk going into default on your home.
Read Also: Should I Borrow From My 401k
