Chapter 18: When You Need a Down Payment
Should You Borrow from Your Retirement Plan or Liquidate Your Retirement Plan? Down Payment Options When Borrowing More Than the County VA Loan Limit
- Often a better rate of interest than unsecured consumer loans.
- Pay yourself back with interest.
- Avoiding penalties and income tax liabilities.
- You were ordered or called to active duty after Sept. 11, 2001.
- You were ordered or called to active duty for a period of more than 179 days or for an indefinite period because you are a member of a reserve unit.
- The distribution is from an IRA or from an elective-deferral plan, such as a 401(k) or 403(b) plan or a similar arrangement and taken during the active duty period.
- Early IRA withdrawals also are penalty-free in a few other instances, including a first time home purchase. Anyone, including Veterans can currently take advantage of this first-time homebuyer exemption. You qualify under this tax rule as long as you (or your spouse) didn't own a principal residence at any time during the previous two years. This wouldn’t apply if you were selling your home and buying a larger home. And that’s a common circumstance when our VA buyers need some extra money for the down payment on the new larger home.
- Payments for mortgage interest or payments on a business loan are tax deductible. Payments to your retirement plan are not tax deductible. Therefore, you're repaying your retirement loan with “after-tax money” (income that has already been taxed), and then later, when you withdraw the funds in retirement, you'll pay taxes on that same money again. In this manner, borrowing against your retirement plan could be considered paying taxes twice.
- In many plans, borrowing money from your 401(k) means that you're selling positions that are invested, equal to the loan amount. You’ll be forgoing the potential profits and the power of compounding your returns when the investments appreciate. And as you pay back the loan, you're repurchasing the previously sold shares but at current (and probably higher) prices.
- Some plans won't allow you to contribute to your 401(k) until you've paid off your loan.
- Many retirement plan loans must be repaid within five years. If you can’t repay in that time frame, your employer will treat the loan balance as a distribution, triggering income taxes and the ten percent early withdrawal penalty if you're under age 59½. You could also be denied the opportunity of contributing to the plan in the future.
- If you leave your job, the loan may become due and payable within a short period of time. If you don't repay the loan when due, the IRS will consider the unpaid balance to be taxable income.