The COVID-19 pandemic has brought incredible economic hardship to businesses and individuals. At the same time, it has brought unique opportunities to people who are in the market to buy their first home. Read on to learn how you may be able to leverage the CARES Act to help finance a mortgage.
What Is it?
Also known as the CARES Act, The Coronavirus Aid, Relief, and Economic Security Act was a $2.2 trillion economic stimulus bill passed by Congress in response to the economic fallout of the coronavirus pandemic in the United States. Among other things, the legislation includes direct economic relief for businesses and individuals in the form of checks, grants and low-interest loans. It also included waivers that allowed people to tap their 401(k)s early without incurring penalties.
Overcoming the Dreaded Down Payment Obstacle
One of the greatest obstacles facing first-time homebuyers is coming up with a sizable down payment. The CARES Act provides an opportunity for prospective buyers to fund their down payments by accessing their 401(k)s.
The ability to tap into retirement funds was a measure put in place to help combat emergencies. That said, the CARES Act does not forbid anyone from tapping into their retirement savings to help fund a down payment for a new home.
Usually, the purchase of a first home wouldn’t qualify as an exception for early withdrawal or distribution from a 401(k) plan; however, the CARES Act allows certain qualified individuals to borrow up to 100% of their 401(k)’s vested balance. It also waives any early withdrawal penalties for distributions up to $100,000 even if you’re under the age of 59½. That said, distributions must occur in response to financial hardship as a result of COVID-19.
To qualify, you must meet at least one of the following criteria:
- You, a spouse or dependent received a positive COVID-19 test approved by the Centers for Disease Control and Prevention
- You experienced adverse financial consequences as a result of being furloughed, quarantined or laid off due to COVID-19
- You experienced adverse financial consequences as a result of being unable to work due to lack of child care due to COVID-19
- You are a business owner that experienced adverse financial consequences due to having to shutter or reduce hours due to COVID-19
Maximum Loan Amount
The maximum loan amount you can borrow is usually a $50,000 maximum or 50% of the vested account balance. The vested balance is the amount of money in the 401(k) you “own”. Contributions by employees are always 100% vested, but contributions by an employer may require a few years of service by the employee to be considered vested. This depends on the details in your retirement plan documents.
An exception to this set limit is if 50% of the vested balance falls under $10,000. In this case, you can borrow up to $10,000.
Why it’s a Good Idea
If you are eligible, there are a lot of good reasons to look into leveraging the CARES Act distribution from your retirement plan to help buy a home. For one, there’s no obligation to pay back the loan. That said, if you do repay your COVID-19-related distribution within three years, it will be treated as a non-taxable “direct trustee-to-trustee transfer.” If you don’t pay it back, on the other hand, you will be taxed at a rate of 20%.
Bear in mind that most (but not all employers) have agreed to participate in this CARES Act provision, so you will have to confirm that your employer is participating. You will also face the prospect of lost compounding interest on your retirement investment.
If you’re not sure whether tapping your 401(k) to help buy a home is a good choice, talk to your financial advisor. You should also talk to a reputable real estate agent to determine if now is a good time to buy a home, since home values and market conditions will work to determine whether you are making a wise investment.
With more than six decades of collective real estate experience, The Wheaton Team provides comprehensive guidance and expert advice for our clients. Specializing in residential real estate throughout Colorado Springs, our team can guide you through the complex buying and financing process. Contact our attentive, knowledgeable real estate professionals to learn more.