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Debt & Planning

Pre-Approved versus Pre-Qualified

When it comes to home financing, your first move can easily determine how the rest of the process goes. You have two choices – get pre-qualified for a mortgage or get pre-approved.

Getting pre-qualified means a lender has given you an estimated mortgage amount based on a general discussion about your finances and maybe a credit pull.

Getting pre-approved means you have a written pre-approval from a lender for a specific mortgage amount based on a detailed financial analysis and credit check; it’s basically a complete verification of the same information that is only discussed in pre-qualification; there is more about this below.  Going this route, ensures that there are no potential red flags that could derail your loan later in the process.  More people are choosing pre-approval as their first step because it offers three potential benefits:

Saves Time

Getting pre-approved means you have a clear budget and price range. Shopping online, meeting with a realtor, and negotiating with the seller will be easier and faster.

Saves Money

During negotiations, the seller may give you a better price knowing that you have a definite source of funds.

Better Chance of Getting the Home

Let’s say the seller has multiple offers on a home. If you’re pre-approved while the other buyers are only pre-qualified (or less), the seller is must more likely to choose your offer.

The message is simple – a bigger commitment in the beginning can lead to a bigger benefit in the end. Let Envoy Mortgage help you take the first step to the Wisconsin home of your dreams, contact me or read about the ways to prepare for your pre-approval appointment here.

Borrowing your Down Payment from your 401(k)

Nest Egg IOU - Borrowing against 401(k) for a Wisconsin home loan

Disclaimer: This should not be construed as financial advice for your specific situation. This is merely what I have learned in my research. To ensure that borrowing from your 401(k) is the right thing for your personal situation, please consult your financial adviser and/or your accountant.

As you probably know, many employers allow their employees to borrower money from their 401(k) plan for various reasons. The reason I have been researching, of course, would be borrowing money for a down payment on a home. Ensuring that you understand the pros and cons of doing so is important.

Here are several things I have found that may help you when considering this for your specific situation:

  1. No Credit Check Required – Typically, no credit check is performed because you are not technically borrowing any money. Instead, you are technically utilizing your retirement funds. Because no financial institution is lending you funds, there’s really no need to check your credit.
  2. Lost Investment Growth – The funds you borrow from your retirement account will not be invested toward retirement while the money is outstanding from your account. That said, you would be foregoing all potential investment income while the loan is outstanding. But…
  3. Pay a Competitive Interest Rate…to Yourself – Regardless of your credit score (for reasons already noted), you will pay a competitive rate. It’s usually a rate similar to consumer loans. The best part, however, is that you will get to pay the loan, including the interest, to yourself…not a bank. The whole amount of each loan repayment goes to your 401(k) account.
  4. Borrowing Limits – Generally speaking, you can borrow the lesser of one half of your retirement plan balance or $50K. You must begin payback immediately – in most cases – through automated deductions from your paycheck.
  5. Loan Length Restrictions – While I am focusing my research on home purchases, this is still notable because of the Risk of Termination noted in the next point. Usually, unless you borrow money from your account to acquire a home, you must keep your loan payback term to five years or less. For home purchases, however, you can often extend it much further. However, the longer you draw it out, the more likely the following point will be an issue…
  6. Risk of Termination – No matter how it comes about, if you stop working with your current employer, your entire loan will usually be due within 60 days. If you cannot pay it back during that time-frame, the entire balance you haven’t paid back will be deemed a distribution and, in turn, will probably be subject to federal income taxes, state income taxes and penalties for early retirement distributions.
  7. Little-to-No Application Fees – being that you are borrowing from yourself, usually the fees are nonexistent. Some plans do have these fees, but they appear to not be common.
  8. Negative Tax Impact – When you repay your loan, you are doing so with after-tax dollars. As a result, your loan payment (say, $50) directly lowers your take home pay by its amount (in this example, that’s $50). Of course, when you take that money out later in retirement, you will pay taxes on it again.
  9. A Loan is better than a Distribution – It’s clear that there are benefits and there are negatives to borrowing against a 401(k). What is certain is that it should be used only as a second to last resort. What would be an absolute last resort is a distribution because said distribution would have all sorts of negative tax implications.

As always, if you have questions, please contact me.