Juggling to buy new home

The Baltimore Sun

When it comes to mortgages these days, timing is everything.

Mike, from the Frederick County community of Middletown, is in the process of selling one house and buying another and finds that rapidly changing market conditions have wrenched his financing plans.

"With recent market conditions changing (my home sale price, stock market drops and interest rate hikes), I may need to take a $20,000 loan from my 401(k) to pay for closing costs on my new home," he writes in an e-mail. (He's already taken out a home-equity loan on his current townhouse to make the 10 percent down payment on his new home under construction.)

The 33-year-old salesman says he knows the pitfalls of borrowing from a 401(k). If he lost his job, for instance, he would have to repay the loan immediately or otherwise pay income taxes and a penalty on the money he took out. On top of that, any money borrowed would no longer be invested and growing.

He figures if he borrowed from the 401(k) he could repay the loan within five years at an annual percentage rate of about 9 percent.

What if he, instead, borrowed from the retirement account and then took out a home equity loan right after closing on his new home to repay the 401(k) loan?

"I might get a lower rate, I don't lose on 401(k) growth and I get the tax benefits on repayment of the home equity," he writes.

What Mike suggests would have been a lot easier just two months ago, says David Pulford Jr., president of the Maryland Mortgage Bankers Association.

Lenders have been tightening underwriting standards since trouble surfaced in the subprime market. Credit isn't easy to come by now for those who don't have a relationship with a bank and a FICO credit score of 700 and up, Pulford says. Two months ago, borrowers had little trouble getting credit with a score of 620 or 640, he says.

"The more equity he has in the home, the better the chance he has of actually succeeding," Pulford says of Mike's situation.

Mike's likely options are a home-equity line with an adjustable interest rate and a fixed-rate home-equity loan, Pulford says. Given today's environment, Mike is better off with a fixed-rate loan for five or 10 years, he says.

Even then, Pulford says, the interest rate on the second loan may not be much better than the rate on a 401(k) loan. "He may not have a big advantage on interest, but it would be deductible interest," Pulford says.

Mike should sit down and talk to a lender about his options.

Usually, financial planners dissuade workers from dipping into a 401(k) for purposes other than retirement.

Gaithersburg planner Christopher Brown says he is not entirely opposed to using 401(k) money for a down payment on a house if the worker is a disciplined saver who has been maxing out 401(k) contributions.

Most of the time, that's not the case, he says. He worries that workers tap a 401(k) for a house they can't afford. And if they have no other cash cushion, they may not be able to afford all the other things that go with owning a home, such as furniture and maintenance, Brown says.

Warren of Annapolis had a follow-up question to last week's column about cashing in EE savings bonds to pay for education. Parents don't have to pay federal taxes on the interest earned provided the money is used for a child's college education.

Warren, who has a granddaughter in high school, wondered if grandparents, too, are eligible for tax-free redemptions if they paying for a grandchild's college tuition.

The answer will be "no" in most cases.

Theresa Bandell, manager of Stegman & Co. in Towson, says grandparents can get this tax break only if the grandchild is claimed as a dependent on their tax return. Otherwise, only adults redeeming bonds for their own education or that of a spouse or dependent are eligible.

Questions? Comments? Write personal.finance@baltsun.com

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