Author Topic: 401k Loan to Facilitate Buying before Selling  (Read 2461 times)

mandydean

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401k Loan to Facilitate Buying before Selling
« on: February 18, 2016, 12:39:18 PM »
Hi all,

I'm looking for some advice / insight / tales of experience.

We are currently trying to sell our small home to buy a larger home in the same town. Since we bought we've had 3 children and we've just outgrown it. Our home is on the market now, and our area is definitely a buyer's market. We have about 50% equity in our home, so plenty of room to play around with the listing price and still make a good chunk of equity.

I know, generally, advice is to sell before buying. But I'll lay out my case for wanting to go ahead and buy now: We've got 3 small children and keeping our home show-ready is almost impossible. I love the idea of emptying the house now. And the bigger concern is that we have no clue where we would live in the interim between selling and buying. There is only one set of apartments in town that does short term rentals, and the cost on them is 2500/month - this may not sound like much to those of you in HCOL areas, but for us, 2 or 3 months at that rental price would literally put us into an entirely different home-buying bracket. That's about 4 times our mortgage payment (on a 15-year loan!). That would eat our down payment in a hurry.

We've found a house that we love. We're familiar with the market in our area, and this is not the kind of home that comes up often. It's at the very bottom of our price range, and (you guys will like this) it's an energy advantage home, which is almost impossible to find in our area full of spec-house-neighborhoods. We've looked at a lot, but this is the house we keep coming back to. I don't think we'll find the space we need and location we like for close to this price. This home would allow us to get a 15 or 20 year term instead of 30.

We've been pre-approved for a loan on top of our existing mortgage. The only missing detail would be our down payment. From what I read, bridge loans have their own set of closing costs for the "bridge" as well as the following purchase loan, and have higher interest rates. Not interested in that. I suggested to my husband that instead, we consider borrowing from his 401k to make the down payment. From what I can tell, the cost would be about $50 to administer the loan, and then whatever we would have earned (or potentially lost) on the investment for the duration of the loan. We'd be able to make both mortgage payments from our budget (though we'd likely also decrease his retirement contribution from 11% to 6% during the double-mortgage period to help ease that cost). We have a 6-month emergency fund that we would not touch. My husband's job is very stable. (I am a SAH/Homeschool mom)

Once our current house sells, we'd take the proceeds and pay off the 401k loan and put the remainder straight to the new mortgage.

My husband is understandably a bit nervous about this. Two mortgages is kind of scary for any duration, even if we can budget for it. I feel like we're prepared to sell our house quickly even if we must drop the price - but of course, nobody can guarantee there will be a buyer at any price. I'm curious if I'm missing out on any aspects or if anyone else has done this.

Jack

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Re: 401k Loan to Facilitate Buying before Selling
« Reply #1 on: February 18, 2016, 12:49:08 PM »
First of all, how viable would your current house be as a rental? Personally, my strategy is to not sell at all if/when I move, and carry mortgages on multiple properties (more than paid for by rental income) on purpose. IMO, the only thing "scary" about two mortgages for a mustachian -- who wouldn't be going by the "your housing should cost 30% of your take-home pay" rule of thumb in the first place -- would be the opportunity cost / lack of ROI on a vacant property.

How much of a down payment are you planning to make (both in terms of percentage of the price and actual dollars)? How does that compare with the amount of your emergency fund (which you'd presumably need to use to immediately pay off the 401k loan if your husband were laid off)?

mandydean

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Re: 401k Loan to Facilitate Buying before Selling
« Reply #2 on: February 18, 2016, 01:11:05 PM »
First of all, how viable would your current house be as a rental?
Very viable - it's close to the local college, the right size, and rentals are very hard to find in our area. However, the overhead of renting the home out is not ideal for us. My husband travels often enough for work that this would be a burden. Still - while I like to think our home wouldn't be vacant property for long, it's good to have as a backup plan if it can't sell.


How much of a down payment are you planning to make (both in terms of percentage of the price and actual dollars)? How does that compare with the amount of your emergency fund (which you'd presumably need to use to immediately pay off the 401k loan if your husband were laid off)?
Expected profits from our home sale will be $45,000, on the safe side, to possible $55k. The 401k loan would be 30,000 which is the max we can borrow. This would be right at 20% of the house we're looking at, which is listed at 150k. We have money set aside for closing costs. Our emergency fund is 15k. As far as repayment, I hadn't considered this. In the case that he did not get a severance, 25k of the loan would have to be repaid (we'll be borrowing the rest from a small fund from when I was employed). We could scrape it together with cash, but no doubt about it - it wouldn't be an ideal situation. But we wouldn't have to borrow to do it.

EDIT: Just looked into terms and his 401k loan would not have to be repaid upon termination - he would have the option of receiving a coupon booklet to continue to make payments.
« Last Edit: February 18, 2016, 01:28:27 PM by mandydean »

CashFlowTurtle

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Re: 401k Loan to Facilitate Buying before Selling
« Reply #3 on: February 18, 2016, 06:43:13 PM »
A few quick points:

1 - I personally love 401k loans, as the cash is (mostly) tax free and your interest 'expense' goes back to yourself (although the post-tax interest expense is taxed again when you withdraw). In my mind, it's free money.

2 - One way to borrow more money on your new home is to get a 'piggy back' loan.  You can usually get great rates on an 80% LTV loan on your primary house, but have to pay very expensive PMI insurance when you borrow above 80% LTV. I borrowed an extra 10% LTV on my house that is a HELOC at a rate similar to my 30 year mortgage (which is much cheaper than an extra PMI payment), and best yet, the interest is tax deductible! I called about 60 banks/credit unions to find the loan that was right for me (I think of those 60, 4 offered some version of a piggy-back loan).

3 - If you do want to keep your place as a student rental, in many places you can get a cash-out refi of your primary residence for 70-75% LTV of the houses value (although I'd advise you provide the comps tot he appraiser, they usually don't like people cashing out too much money).  There is an origination fee on a new mortgage, but the interest is tax deductible, and you can get the source of funds for the down payment. Ultimately, do the math on the income from the potential tenants and make sure they more than cover the mortgage (without any info, I'd recommend rent be somewhere in the ballpark of at least 2x the mortgage payment, college kids can be rough). Rental property is a great way to build wealth.

Fishingmn

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Re: 401k Loan to Facilitate Buying before Selling
« Reply #4 on: February 19, 2016, 06:10:03 AM »
You left out one item. How long has the house been on the market? In other words, why hasn't it sold?

In our market if it hasn't sold in 2-3 weeks it's probably overpriced. You could decide to drop the price substantially to get the house sold which would facilitate buying the other home.

The 401k loan is certainly an option but you want to get the house sold so you might consider how to make that happen faster.

mandydean

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Re: 401k Loan to Facilitate Buying before Selling
« Reply #5 on: February 21, 2016, 07:55:40 AM »

2 - One way to borrow more money on your new home is to get a 'piggy back' loan.  You can usually get great rates on an 80% LTV loan on your primary house, but have to pay very expensive PMI insurance when you borrow above 80% LTV. I borrowed an extra 10% LTV on my house that is a HELOC at a rate similar to my 30 year mortgage (which is much cheaper than an extra PMI payment), and best yet, the interest is tax deductible! I called about 60 banks/credit unions to find the loan that was right for me (I think of those 60, 4 offered some version of a piggy-back loan).

Will look into this. We are less concerned about PMI (would just be paying this for however many months we waited for our current to sell, and then pay to less than 80%) but more concerned about the interest rates jumping if you don't have the 20% down. I suspect a piggy back loan would also come with a fee in the form of higher rates, but I'll see what I can find!

3 - If you do want to keep your place as a student rental, in many places you can get a cash-out refi of your primary residence for 70-75% LTV of the houses value (although I'd advise you provide the comps tot he appraiser, they usually don't like people cashing out too much money).  There is an origination fee on a new mortgage, but the interest is tax deductible, and you can get the source of funds for the down payment. Ultimately, do the math on the income from the potential tenants and make sure they more than cover the mortgage (without any info, I'd recommend rent be somewhere in the ballpark of at least 2x the mortgage payment, college kids can be rough). Rental property is a great way to build wealth.

We re-financed a couple years ago and currently our loan is only about 50% LTV, but we are on a 10-year mortgage which would make it hard to charge rent for much more than our payment. Refinancing would be the best solution if we decided to rent the home long-term, and we'll discuss it. I hate the idea of renting, but perhaps you're right. It would build wealth and we could refinance down to very affordable payments.

mandydean

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Re: 401k Loan to Facilitate Buying before Selling
« Reply #6 on: February 21, 2016, 07:58:16 AM »
You left out one item. How long has the house been on the market? In other words, why hasn't it sold?

In our market if it hasn't sold in 2-3 weeks it's probably overpriced. You could decide to drop the price substantially to get the house sold which would facilitate buying the other home.

The 401k loan is certainly an option but you want to get the house sold so you might consider how to make that happen faster.

Home has been on the market for 6 weeks. Normally in our market, that's totally ok. But - the house hasn't had many showings in 6 weeks, either, so we have just dropped the price this weekend. It's an INCREDIBLY slow season here and we have a fantastic realtor who knows the market and is an honest advisor. Any impatience to sell is entirely our own.

Another Reader

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Re: 401k Loan to Facilitate Buying before Selling
« Reply #7 on: February 21, 2016, 09:42:29 AM »
IIRC, if you refinance your current house as an owner-occupant with a conventional loan, you cannot finance another owner-occupied home with a conventional loan for a year.  I would verify this with your lender before doing anything.

In your shoes, I would not borrow from a 401k to buy a new house.  If I had to borrow the down payment, I would not buy the house, because I would be taking on too much risk.  I would be undercapitalized and in a world of hurt if something went wrong.

What I'm hearing is a lot of rationalizations for borrowing to buy.  If the housing market is slow, then the new house is not likely to sell either.  If it's the steal of the century (not likely), then lower the price on your house enough to get it sold.