Question: There's a topic I'm very interested in learning about, and not sure if you've covered it in the past. But I am wondering about borrowing from 401Ks and IRAs to buy a home. What are the options? The pros and cons? Does it apply to new homes only? When do you have to pay them back? Jakki Glivicky, Boston.
Answer: My first thought about using retirement funds to purchase a house is don't. If this is the only way you can scrape up enough dough to cover your closing costs and a minimal down payment, you probably shouldn't be buying a house. But after talking to Austin, Texas, mortgage banker David Reed, I'm not so sure.
Reed's not a financial planner or retirement expert, by any means. But he once borrowed from his 401(k) to buy his present home and he told me it couldn't have worked out better.
"Worked great for me," he said. "We were house hunting and a home came up quicker than we thought. We didn't have 20% down, so I borrowed 10% from my 401(k) and got an 80/10/10." That's an 80% mortgage with 10% down and a 10 percent second mortgage or home-equity loan; in Reed's case, from his retirement money.
Now you certainly don't need to make a 20% down payment. Reed was doing it to avoid private mortgage insurance, which borrowers pay for, even though it protects lenders in case the borrower doesn't make payments. All kinds of loans are available today for as little as 3% down, or even less. But you have to pay PMI, which can add $100 or more to your payment each month.
Most financial planners have apoplexy when anyone talks about disturbing their retirement money. But let's look at this a little deeper, first the 401(k) and then an IRA.
Generally, 401(k) loans are limited to 50% of your vested balance. And the amount must be paid back each and every paycheck, usually over a four-year term. Reed, who covers this stuff in a chapter in his new book, "Who Says You Can't Buy a House?" (AMACOM), says the typical 401(k) loan -- it's not really a loan per se but rather a transfer of assets -- is at a rate of prime plus one percentage point. So if the prime rate is 6% you'd pay 7%.
Most anyone who is fully vested and a full-time employee can draw money from a 401(k). After all, it's your money. No credit report, no debt-to-income rations, no tax, no penalty for early withdrawal, no nothing. But the drawback, of course, is that once the money is removed from your account, you no longer are earning a return on it.
You can't borrow from your IRA account. You can only withdraw from it, and there are stiff penalties if you pull out money before you are 591/2 years old. The law allows you to withdraw money without penalty if you yourself are a first-time buyer -- how many first-timers have an IRA brimming with enough cash for a down payment? -- or if you want to help your child, grandchild or other direct relative buy their first place.
However, the law limits the maximum withdrawal to $10,000 for an individual taxpayer and $20,000 for a husband and wife withdrawing together. And of course, unless the money is put back into the account, and there is no requirement that it must be, it's earning power is lost forever, at least in the form of a retirement asset, unless you put it back.
Homeownership isn't a bad form of retirement asset. It may even turn out to be a better one than an IRA. But unless you are the first-time buyer, it's an asset for someone else, not you.
All in all, though, I wouldn't touch your retirement funds in any way, shape or form until you have a sit-down with a financial planner of certified public accountant.
And no, you are not limited to just new construction when you tap into your retirement nest-egg for the down payment. You can buy an existing house, too.
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