Buying That First Home Round Two - Part 4

So now you have a sense of things.  The next thing to know seems obvious, but many people make a critical mistake when going hunting for a home:

Get Your Funding In Order.

What do I mean when I say "funding"?  At first, you might be tempted to think, "oh, he means get a loan".  Actually, that's one small piece of it.  

For this post, "funding" refers to anything financial that applies to you.  Here's a quick list, and then I'll go through each and what you need to know on each.  Some, I'll dig into on a later post, but this is just to get your brain churning in advance.

• Retirement Funds: Yes, you need to think about these during your home purchase.   Why?  I'll tell you in a moment.
• Savings: While your retirement is also "savings", this refers more to liquid assets that you're putting away for a rainy day.  You are, aren't you?  No?  This post is for you.
• Cash On Hand: Refers to any money that isn't in an account somewhere.  You do need to have a handle on this, and I'll even tell you about a nifty trick (of course, that's assuming you're not flat broke).
• Borrowed Money: This isn't referring to a loan, this is referring to money that you're getting from a friend, family member, coworker, or whatever with the intent of paying them back at some future date.
• Credit Money: Still not referring to a loan.  This is where you might try to draft money out of a line of credit, credit card, or other revolving source of money.  Obviously, a stupid idea, but I list it here because there are things you need to know about it should you choose to do it.
• Bonds: Not heard as frequently anymore, but if you were one of those lucky kids whose parents loved you enough to buy you bonds as a birthday present rather than Transformers, it might just be your lucky day.
• Loans: Ahh, NOW we're getting to the good stuff.  But wait...I'm not yet referring to the actual mortgage.  I'm referring to any OTHER loan you might be getting or considering.  There are tricks and problems with this and I'll tell you all about them.
• Mortgage Loan: Last but not least, is the mortgage itself.  I list it last because frankly, depending on what you did with the other listed items, you may not even get a mortgage.  Let's hope that you were money smart though.

First up...

Retirement Funds

If you're working, you likely have a 401k account.  That account is likely with either Fidelity or Schwab.  It may also be with a smaller 401k administrator, but they're becoming less and less prevalent these days unlike back in the 90's.  The way your 401k program works is dictated by your employer.  They tell Fidelity/Schwab what you can and cannot do with the money in your 401k.  You might even have the option to withdraw from it if you want to buy a home or you're low on funds.  The key to this account is that if you have money there, DO NOT withdraw it to buy a home.

What??

I said, DO NOT WITHDRAW FROM YOUR 401K TO BUY A HOME.

The reason is very simple: taxes.  If you withdraw from your 401k, you'll get nailed with a tax penalty ranging anywhere from 20% to 30% depending on what state you're in.  That's, as Billy Mays would have said, "cash in the trash".  Worse, that money won't be available at retirement (which is of course the point), nor will the taxed money.  You're throwing it away, and you should not do that.  Instead, try to get a 401k loan.  The beauty of a 401k loan is numerous, and not many people realize it:

1. The interest rates are extremely low: between 2%-4%.
2. There's no credit check.  Your credit has nothing to do with getting the loan; you're approved so long as you have vested funds.
3. The interest you do pay on the loan, goes back into your account.  You're paying yourself, basically.
4. Some 401k programs offer loans specifically for buying a home vs. general purposes.  Home purchases require paperwork; general loans do not, but neither require anything from you other than to request a certain amount of money and you can do it all online, yourself.
5. The loan does not show on your credit report or impact your credit score.
6. You can take up to 5 years or longer to repay the loan.  In some cases, such as for the home loan, you can take 10-30 years if you need (this is often overkill).
7. The loan is repaid through pre-tax deductions on your paycheck, so you don't even need to worry about managing the payments each month.  It just gets done.

This is what you should do, if you need money for closing costs or down payment.  Your lender will ask you if you intend to do this, make sure you disclose that you've done this or plan to do this.  It's fine, it won't affect you getting the loan, but they need to document exactly where you got the money from for legal reasons.  You'll be asked to produce paperwork showing the request, the deposit, and the money in the account.

At this point you're asking, "but what if I get laid off/fired"?  Well, you'll have 30 days to repay the loan.  If you don't, it's treated as a withdrawal and you'll be nailed with the taxes I referred to earlier.  But that's ok...because you'll be able to use some of your severance (assuming you got one) to pay that.  Or, you might end up not making enough if you're let go halfway through the year, and your tax burden will end up lower, offsetting this.  Although, if this were to happen before you got the home, you wouldn't need the loan anyway, and you can just return the money.  If this happened after you got the home, the property tax and other deductions may offset the tax penalty.  It's all unknown, but that's the risk we all take when dealing with money.

Next time I'll get into savings...a topic most people cringe from.