Posts Tagged ‘down payment’

Borrowing from your 401k for down payment on a home

Should you borrow money from your 401k for a down payment on a home? A home is one of your most valuable assets but is it worth your retirement funds? I’m going to give you several reasons why you SHOULD NOT borrow from your 401k retirement fund to purchase a home.

First, when you contribute to your 401k fund you do so with pre-tax dollars. You are required to pay back the loan and that money will be with after tax money, that money will be taxed again when you decide to take it out at retirement.

Second, if you borrow from your 401k then many lenders will view this as an additional debt, just like a car loan or credit card loan. This could hurt your debt to income ratio, in turn giving you a higher interest rate on your mortgage loan or reducing the amount of money you can borrow for a home.

Third, as mentioned above this will become another monthly debt and you will be obligated to repay the 401k loan, usually over a course of time shorter than the mortgage loan. This payment will be in addition to the mortgage payment, which could put an extra strain on your monthly budget.

Next, you could have to repay the loan early if you lose your job for any reason. There is usually a clause in the 401k loan documents that requires you to repay the loan in full within 30 days if you leave your job for any reason or you are fired. If you don’t repay the loan you will face early withdrawal penalties of 10% as well as having to pay income taxes on the money. This will not only put a strain on you now, but will destroy much needed funds for your future.

Finally, some 401k funds will not allow you to contribute extra funds toward retirement until the loan is paid back in full. Not only does this limit the growth potential of your normal deposit, but you also lose any matching funds from your employer.

If you are going to need to pay money down for a new home there are other alternatives. Cut back spending and save the extra cash, pick up a part time job, look into a piggyback mortgage, etc. Avoid borrowing from your 401k at all costs.

Piggyback Mortgage Loan Information

A piggyback loan is a mortgage loan in which the financing is handled by two different lenders. The first lender finances a large portion of the loan, usually 80% and another seperate lender finances the remaining balance of the loan. There are three common options of piggyback loans, 80-10-10 loan, the 80-20 loan (also known as the 80-20-0 loan) and the 80-15-5 loan.

An 80-10-10 loan is when the first mortgage finance company finances 80% of the loan amount, the second finance mortgage company finances 10% of the loan balance and 10% of the balance is paid down by the purchaser. The 10% financed by the second lender is basically a second mortgage on the home.

An 80-20 loan is when the first mortgage finance company finances 80% of the loan amount and the second lender finances the remaining 20% of the loan as a second mortgage. No down payment is paid by the borrower or there is already some equity in the home.

The final typical type of piggyback loan is the 80-15-5. The first lender finances 80% of the mortgage balance. The second lender finances a second mortgage for 5% of the loan amount and 5% of the balance is paid down by the buyer.

The biggest pro of a piggyback loan is that 20% of the home value is paid for through a down payment or by the second lender. This means that the first mortgage lender doesn’t charge PMI or private mortgage insurance. Private mortgage insurance is a third party insurance required by lenders if you do not have 20% equity in your home. It protects lenders from borrowers in case they file bankrupsy. A piggyback loan reduces the loan risk of the lender because they aren’t financing the entire amount. Avoiding PMI can save you hundreds of dollars per month depending on the equity and financing terms.

There are three major cons of a piggyback loan. First, you already have a second mortgage on your home. If you ever have an emergency where you need to use your home as equity it will be very difficult since you already have a second mortgage on your home. The second major con is that the second mortgage will haev a higher interest rate than a normal loan with PMI. Sometimes the interest rate can be 2% or 3% higher. Even though your monthly payment may be lower you will end up paying more for the loan in the end. The third major con is that PMI drops off after you have 20% equity in your home. This could happen quick if you overpay your minimum monthly payments. If you don’t have a piggyback loan your payment will decrease once PMI drops off, with a piggyback loan you are stuck with the second mortgage payment until it’s completely paid off.

In my oppinion in most cases you are better off to avoid a piggyback loan. Even though you will have a smaller monthly payment up front you will pay more in the end. Do the math for you own individual situation before you close the loan!