In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses how you can possibly use your retirement funds to buy a house.
Using your IRA or 401(k) to Buy a House
Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial. Welcome to another episode of Adam Talks. Hope all is well, everyone’s having a wonderful day. I wanted to do today’s podcast because mortgage rates at seven plus percent, and I’ve got a number of clients, friends, family as well, saying, hey Adam, is there a way I can potentially use my retirement account since you are the IRA and 401(k) expert. How can I potentially use my retirement account to buy a house? First-time home buyers, listen up! There are some ways. We have not been in this type of interest rate environment in a long time, right? We are used, we got used to cheap money.
Over the last ten years, any interest rate over 4% or 5% just was something that would give us pause. Now, we’re seeing an interest rate environment where mortgage rates are going to cost anywhere from seven; so I saw a 30-year fixed at 7.6%, ten-year, six year arms, 7.3%, 15 year fixed at 6.7%. This is with a 20% down payment,okay? If you’re going to 15% down payment, you’re looking at higher interest rates. If you’re going to 10% down payment, you’re also going up, okay? So, these rates are the highest we’ve seen in a long time; many, many, many years.
So, what’s happening now is we’ve had a lock-down staring contest in the housing market where sellers aren’t excited about the level of buyer activity and buyers are kind of waiting and saying, hey, I think prices are coming down; I hope interest rates are going to come down. The stock markets recently had bit of a rebound because the feeling on the street is that inflation may not be as bad as we think. And there’s a potential for rates to come down in ’23. If that’s the case, mortgage rates will come down as well. So, we could be in a situation in the next ten to 20 months where the real estate market basically just stays idle. There’s just not a lot of activity.
But, if you’re a first time home buyer or you just want to potentially use some retirement money to buy a home because you feel like prices are coming down or you’re moving somewhere and you need to buy a house and you need some extra money for a down payment, there are opportunities, right? The whole idea of putting, being able to put at least 10% down is you’re not going to get a house with less than 10% down. It’s just really, really difficult, if not impossible. Pre-2008, yeah, you could do it. Now, you’re going to need 10% to 20% down and still, you’re still going to be paying interest rates of six and a half to seven and a half percent, which are super steep, but at least you have the opportunity to buy the house.
So, this podcast is all about, hey, if you have some IRA or 401(k) funds, can you use those funds, and if you can, what are the most tax-efficient ways to use those funds to at least put towards a home?
So, first things first. If you’re a first-time home buyer, section 72(t) of the Internal Revenue Code is your friend and it will allow you to take $10,000 out of your IRA without a 10% early distribution penalty, if you are under age 59 1/2. Now, you still have to pay tax on that $10K, but you save the 10%. Now, I wish that $10,000 was higher; that number has not been adjusted for many, many years. It’s been entrenched in the Code for 40 years or so. So, they have not increased that number, which is troubling, but at least it gives you $10K. So, if you’re looking to buy a house for $300,000 and you need $30K down at least, well, if you have an IRA you can pull $10K out, pay tax, but at least get around the 10% early distribution penalty. So that’s at least better than the alternative of paying the tax and a 10% penalty.
There’s also something called a 60-day. You have 60 days to pull money out of your IRA without tax or penalty and use that for any purpose. Now, here’s the catch. You can only do that once every twelve months and you’ve got to put the money back within 60 days. And if you don’t, whatever you don’t put back is subject to tax and a 10% penalty. So, if you’re in a hole, you need to come up with some money to put down for a mortgage, for a deposit, for rent, or whatever it is, if you are confident you’ll be able to return that money within 60 days, that 60-day rule is kind of a tax-free penalty-free use of the funds for any purpose. But, again, just to recap the rules once every twelve months, you got to return those funds within 60 days, but during the 60-day period you have free rein of those funds.
Now, if you have a 401(k), you have a few more options. Number one, you could take a loan. Most 401(k) plans have a loan feature that will let you borrow $50,000 or 50% of the account value, whatever’s less, and use those proceeds for any purpose, including buying a home. Now, the good news is you actually don’t have to pay that loan back in five years. Because you’re using it to buy a principal residence, you can extend that loan period to 15, 20 or even 30 years. You have the ability to take out a loan that’s reflective of the type of loan that is corresponding to real estate purchases. So you could do a $50,000 or 50% of your account value, whatever’s less. So, if you have $100K, you can borrow up to $50K; $40K, you can borrow $20K, and you can take those funds, use it to buy a home, towards your mortgage down payment, and then instead of having to pay the loan back over five years, like a regular loan, because you’re using it to buy a home, you can extend it over 30 years. Okay, so that’s pretty cool. So it’s your own little mortgage, but again, you have the ability to push that loan to 15, 20 or even 30 years, which is a traditional loan for a home. So, you get the ability to get tax-free, penalty-free use of those funds, and you also don’t have to pay back for at least 30 years.
Now, one thing I want to be clear, it’s for first home purchases, okay? So that’s the catch. It’s for first-time home buyers; for the, at least the $10,000 distribution I mentioned, right? The first-time home buyer is important, right? That’s that $10,000 and if you want to take the loan out, you’re able to extend that loan payment over the 30 years as well. So, that’s an interesting exception that a lot of people just aren’t aware of, which obviously comes in quite handy when you need to use those funds to purchase a home, okay? So just remember that it’s a principal residence. So the $10,000 is for first-time home buyers, and the loan is for a principal residence. It does not have to be a first-time home purchase. It could be your 10th home, your fifth home, but it needs to be your principal resident, not a second vacation home or just an investment property; principal business. So, you get to extend that $50,000 or 50% account value over 20, 30 year loan. The minimum interest rate you have to use now as of November or mid-November, 2022 is 7%, which is the highest it’s been, as far as I remember, at least 15 years. And just think about it, a year ago today was 3.25%, so it’s gone up more than double, but you’re paying yourself back.
That 7% doesn’t go to a bank, doesn’t go to Visa, it goes to you. And you can extend a loan for a principal residence instead of five years, which would be the duration for a regular loan, you can extend it to 30 years. So, you can use those funds for a down payment. Let’s say you’re buying a home for $400 grand. You need to come up with, let’s say, $50 grand, and you maybe have $10-15 grand lying around in a savings account, but you have $100K in your 401(k), you can borrow the $50K, or at least up to it, use it for a down payment, and then pay your plan back the 7% over a 30-year period. So, the interest, the loan payments, it’s a flat straight-line loan, so it’s not a balloon payment, but instead of paying it over five years, you get to pay it over 30 years, which obviously is a huge, huge advantage.
What else can you do with a 401(k)? Well, you got the loan feature. Also, from an IRA or 401(k), this is really, I would say, a strategy if you have family members, non-lineal, so siblings, cousins, aunts, uncles that maybe need money to buy a home, and you have money in your retirement account, you can serve as a lender to them. So they may say, well, interest rates are so damn high, Adam, I really need to buy a home. I need $30 or $40 grand, I don’t have the money or I need to fix up my home, whatever it is. And you can say, okay, I’ll lend it to you at 4% or 5% or 6%. You have flexibility. Now, the one caveat is, under the prohibited transaction rules, you’re not able to do any transactions with a disqualified person, which is a parent, child, spouse, daughter-in-law, son-in-law, or any entities you control or are controlled by such persons. But, brothers, sisters, aunts, uncles, cousins, friends, neighbors, they’re all good.
So, you can do an investment, a loan transaction with such person. So, if your brother or sister needs money for a down payment for a home, or, God forbid, needs money for medical expenses or credit card expenses or needs to fix up their home because of, God forbid, a hurricane or whatever it is, you can lend those funds; you can’t gift it, but you could lend it. It doesn’t have to be 7%, it could be 3% or 2% or 4%. Lend it to your siblings. This way you can get a rate of return, whatever that interest is and you’re also helping your family members out if they need to buy a home or just need cash for whatever reason. So, that’s another interesting thing you can do with an IRA or 401(k) in the self-directed world, is you have the ability to structure alternative asset investments like a loan, so long as you’re not lending it to a disqualified person, a parent, child, spouse, daughter-in-law, son-in-law, or any entities controlled by such persons. So, brothers, sisters, aunts, uncles, cousins, neighbors, friends, those are all fair game and you could transact with such person.
So, just to summarize, we’re in a tough environment if you were looking to buy a home. Just the bottom line; interest rates have doubled, more than doubled in the last year. The good news is prices are coming down, but it’s still not a buyer’s market at this point. But let’s say you just want to buy a home. You just are sick of paying rent, you need stability, you don’t want your rent increased every year or you’re moving and you just need to buy a home. You have a couple of options.
Here’s a summary: IRA, $10,000 first-time home buyer, pay tax but get around the 10% penalty. If you need short term use of money, you can do a 60-day in-kind distribution. Take it all out once every twelve months, but you got to return it within 60 days. If you have a 401(k), it has a loan option, you can borrow the lesser of $50,000 50% of your account value. Use a loan for any purpose, including for a mortgage and instead of having to pay the loan back over five years at a prime interest rate of 7%, you can extend that loan period to 30 years, which obviously will significantly reduce your payments back to your 401(k). But again, the good news is you get tax-free, penalty-free use of the money and you’re paying yourself back instead of a bank.
And then alternately, on a big picture, from an investment standpoint, you could use an IRA or 401(k) to do a self-directed loan investment. So altruistically, you can help a friend, neighbor or family member who maybe wants to buy a home, or has damages from a hurricane, or needs to fix their home, or has medical expenses, whatever the case may be, you can help those folks out. And at the same time, you can generate a rate of return for your IRA or 401(k) through a loan instrument. You don’t have to use the prime rate, just can’t be a gift, so you need to have some sort of interest, whether it’s 2%, 3%, 4%. But, this way you can help a family member, a friend out, not a lineal descendant, but for example, a brother or sister or neighbor, and also get a nice rate of return for your retirement plan.
So there it is. I hope today’s podcast helped at least some of you. If you are a first-time home buyer, you have that IRA potential $10,000 penalty exemption. If you just want to buy a home, primary residence and you have a 401(k), you can do the loan feature. If you have an IRA but don’t have access to a 401(k) at work, but you’re self employed, we can always set you up with a Solo 401(k). That will let you move your IRA to a Solo K and then do a loan of $50,000 or 50% of your account value, whatever’s less. Use that loan for any purpose, including buying a principal residence and that loan now doesn’t have to be paid back for 30 years.
So again, if you’re self-employed and have a business with no full-time employees, you have some options with the Solo K where you can, obviously, if you so desire, do a loan of $50,000 or 50% of your account value and then have that loan payback terms extended from five to 30 years, which is obviously super attractive. So, those are really the core options you have. If you have an IRA or 401(k) and you want to tap into it to buy a principal residence, or if you’re a first-time home buyer, there is that additional option for IRA holders.
So, I wish that $10,000 number increased for inflation. That number would be great if it was around $30,000 or $40,000, because the way home prices have increased over the last eight to ten years, you know, ten grand just doesn’t move the needle anymore. But from a loan standpoint, that 401(k) loan of $50K, that helps, right? If you want to buy a home of $300K, $400K, $500, $600K, that extra $50K, that can make or break you getting that mortgage. Now again, mortgage rates are exceedingly high now, but if you need to buy the house and getting that down payment, putting more down will help obviously decrease the amount of mortgage you need, which will decrease the amount of interest you have to pay on those funds.
But, the bottom line is interest rates are super high now. A lot of buyers are just standing idle; they’re on the sideline. The thinking is, hey, there’ll probably be one more rate hike in ’23, mid to end of ’23, rates will come down again, inflation will be tempered and the economy may sputter and it could force the Fed to lower rates in order to accelerate more demand from consumers and help the economy out and that will obviously bring mortgage rates down because they coincide with interest rates. So, no one knows obviously what’s going to happen, but seems to be that’s the, I guess, I don’t want to say smart approach, but that’s what a lot of economists are thinking, that there could be one more rate hike maximum and it’s potential that even in ’23, rates will start coming down because of some of the weakness in the economy. But to be determined, who knows? But, my job here is just to give you guys the best, most tax efficient options to tap into your retirement account to help buy a home.
Now, obviously in a perfect world, you don’t need to tap into your retirement to buy a home; you have plenty of money in your pocket or in your savings account or in your investment account to do that, but that world doesn’t work that way, right? Everything kind of happens and sometimes you just need to borrow a bit from your retirement account to take care of an immediate need, which is okay, there’s nothing to be ashamed of. You just want to do it the right and smart way so you don’t have to pay, or you can at least minimize the amount of tax you have to pay on that potential distribution. And the best part of it is the 401(k) loan option; there’s no tax or penalty. So, it’s a real tax-free, penalty-free to get use of those funds and then have that 30-year window to pay off that loan, which I think is ultimately the best option.
So, thanks again for listening; if you’re watching on YouTube, really appreciate it. Have an amazing week and I’ll see everyone again next Wednesday. Take care.