In today’s competitive real estate market, finding your dream home is exciting, but financing it can be challenging, especially if your funds are tied up in your current property. With many sellers hesitant to accept offers contingent on the sale of an existing home, buyers often face the dilemma of securing a down payment while potentially carrying two mortgages. Fortunately, there’s a strategic approach that can help: using a 401(k) loan to fund your new home purchase, followed by recasting your mortgage once your current home sells. This strategy, while not suitable for everyone, can offer a practical solution for those with significant equity and a vested 401(k) balance.
Phase 1: Leveraging a 401(k) Loan If you’re short on liquid cash for a down payment, consider taking out a loan from your 401(k) account—if your plan allows it. This option enables you to borrow up to $50,000 or 50% of your vested balance, whichever is less. For couples, both spouses can take loans from their respective accounts, potentially doubling your borrowing power.
The advantage of borrowing from your 401(k) is that you’re essentially paying yourself back, including the interest. Most plans set the interest rate at the prime rate, which is generally lower than traditional loan rates. However, be mindful of the risks: failing to repay the loan on time can result in the outstanding balance being treated as a taxable distribution, subject to income tax and possible penalties if you’re under 59½. Additionally, if you leave your job, the loan may become due in full immediately, which could be problematic if you’re not prepared.
Phase 2: Managing Dual Homeownership Once you’ve secured your new home with a 401(k) loan, you’ll enter a period of dual homeownership. This phase can be stressful as you juggle two mortgages and the associated costs of insurance, utilities, and maintenance. However, there are some advantages, such as having extra time to prepare your old home for sale or make improvements to your new one.
If your old home doesn’t sell as quickly as expected, you may need to adjust your strategy—perhaps by lowering the asking price or making necessary repairs. In some cases, renting out the property might be an option, but this comes with tax implications. Before making any decisions, discuss your situation with a tax advisor to avoid pitfalls.
Phase 3: Recasting Your Mortgage After selling your old home, it’s time to pay off your 401(k) loan and consider recasting your mortgage. Recasting, or re-amortizing, involves making a lump-sum payment towards your mortgage principal. This reduces the balance and lowers your monthly payments while the original loan terms, including the interest rate and maturity date, remain unchanged.
This process typically requires a minimal fee and can be completed within one to three months, provided you stay on top of the paperwork. However, not all loans qualify for recasting, such as certain government-backed and jumbo loans, so it’s important to check with your lender beforehand. Additionally, if your recast reduces your loan-to-value ratio below a certain threshold, you might be eligible to eliminate private mortgage insurance (PMI), lowering your monthly costs.
Using a 401(k) loan combined with mortgage recasting can be an effective strategy for purchasing your dream home, particularly if you have significant equity and retirement savings. However, this approach comes with certain risks and requires thoughtful consideration. Consult with a Reynolds + Rowella tax advisor to ensure this strategy aligns with your financial goals. Our team is here to guide you through the process, helping you make informed decisions that support your long-term financial well-being.
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve. Our mission is to operate as a financial services firm of outstanding quality. Our efforts are directed at serving our clients in the most efficient and responsive manner possible, delivering services that exceed the expectations of those we serve. The firm has offices at 90 Grove St., Ridgefield, Conn., and 51 Locust Ave., New Canaan, Conn. For more information, please contact Elizabeth Bresnan at 203.438.0161 or email.
