After our article “How to Avoid a Down Payment on a Mortgage” was published, a reader asked us this question:
We just read your column on using pledged asset accounts as collateral for a home loan to avoid PMI. Can IRAs be used as pledged asset accounts, or only non-IRA funds?
An article at WiseStockBuyer.com has a simple answer:
Unfortunately, the IRS frowns upon this; if they find out that you’ve collateralized your IRA, then they’ll consider the entire amount as disbursed – which means you’ll take a 10% penalty on the entire amount.
There is a complex way to get around this, but we don’t recommend the strategy. If you haven’t saved enough to make a down payment that avoids Private Mortgage Insurance (PMI), we recommend waiting and saving until you do have enough.
Some debt is good, but we generally avoid it when possible.
That being said, here is a way to use your IRA assets to avoid Private Mortgage Insurance.
First, you need to roll your IRA into your 401(k). The article elaborates:
There are two caveats, though: you have to have a 401k account with your employer, and your 401k plan administrator has to agree…. First, find out if your 401k plan allows what are called IRA rollovers. If they do, you can then request distribution from your IRA account by contacting your IRA administrator and filling out the required paperwork. It can take up to 60 days to liquidate your assets and have them distributed to your 401k, but once that happens, you can start loan paperwork with the 401k plan.
The 401(k) itself can’t be used as collateral either for your home loan. Instead, most 401(k) plans allow you to borrow money from your 401(k). This would work like a loan where you are both the lender and the debtor. You would have to make monthly payments, with interest, and usually have to pay back the full value of the loan within five years. If you do not, the money you borrowed will be considered to have been an early withdrawal from your 401(k) and thus incur many harsh penalties.
However, when you take out this 401(k) loan to yourself, you can use the money you withdrew to make a larger down payment. That should help put enough equity into the house that you avoid Private Mortgage Insurance. The downside is that now you have two loans: one to the bank for your house and one to yourself, both of which will have interest due.
If you do find yourself in debt, we have a helpful blog series on how to go about paying it off. The best way to get out of debt is to avoid going into debt in the first place.
We understand that there are some things worth going into debt to purchase, but be cautious. The path to a secure retirement is to save more than you spend. Going into debt is the opposite of that.
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