mortgage

Don't raid retirement to fund mortgage

Don Taylorq_v2.gifDear Dr. Don,
My daughter and I would like to purchase a home together. We have been preapproved for a $400,000 loan from a mortgage brokerage firm. We have found the ideal home, but it is $50,000 above the approval amount.

Should I take this amount from my 401(k)? I am 63 and plan to retire in February 2010.
-- Bee Bungalow

a_v2.gifDear Bee,
My first reaction is you should offer the seller $50,000 less for the home and see how that goes before eating into your retirement nest egg. As a buyer with an approved mortgage in hand, you may find the seller is willing to negotiate the price to a level you can afford.

My second reaction is you're buying too much house. You haven't even retired, yet you're willing to cash in $50,000 to $70,000 of your retirement savings (after taxes) and sign a new mortgage at age 63. I'm a big proponent of maintaining some financial flexibility, and cashing in retirement monies to trade up to a house you otherwise couldn't afford doesn't make sense to me.

So to answer your question, I wouldn't recommend taking the money from your 401(k) plan and applying it to the mortgage. I'd recommend you keep looking for the right house.

As a current employee, you'd have to take a loan out against your 401(k) plan -- assuming the plan allows loans. Loans are typically limited to $50,000 or half of the account balance, whichever is less.

When you retire, the loan comes due at separation, but there is no penalty tax on withdrawing the monies to pay off the loan. However, you do owe income tax on the distribution used to pay off the loan.

Alternately, you may be able to take a hardship withdrawal. Among other reasons, the Internal Revenue Service permits hardship withdrawals for the purchase of a principal residence. The IRS publication "Retirement Plans FAQs Regarding Hardship Distributions" explains this in greater depth.

There's a difference between being prequalified and preapproved for a mortgage loan. I'm going to assume you know the difference and are preapproved. If the mortgage banker did the job right, there's not a lot of wiggle room in the size of the loan.

I'm curious how you and your daughter plan to hold the property. Will you own it as joint tenants or tenants in common? Who is contributing to the down payment? Have you drawn up a contract spelling out who is responsible for the various costs associated with homeownership and how the equity in the home will accrete to the owners?

Beyond just what's on the deed and the loan documents, you need to sort through all the issues surrounding the decision to buy a house together. I'd suggest working with a real estate attorney on this purchase.

Read more Dr. Don columns for additional personal finance advice.

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