Are the payments on a loan from your retirement account included in your debt-to-income ratio when you apply for a mortgage?

By Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Edited by Michael Jensen, Mortgage and Finance Guru

Updated October 20, 2020

You may not realize that it is possible to take out a loan from a retirement account such as a 401(k) to help you buy a home. Taking out a loan from a retirement account is different than a withdrawal because you are required to pay it back. The monthly payments on the loan are typically automatically deducted from your paycheck and deposited back into your retirement account.

The unique feature about a loan from your retirement account is that the monthly payments are not included in your debt-to-income ratio when you apply for a mortgage. The payments on a retirement account loan are not counted as debt because the assets that guarantee the loan are owned by you, the applicant, and because you make the payments to yourself.

This is different than almost any other type of debt such as a credit card or car, personal or student loan. The payments for these loans are included in your debt-to-income ratio. The higher your monthly debt expense, the lower the mortgage amount you qualify for.

This is why taking out a loan from your retirement account can provide a significant boost when you apply for a mortgage. You can use the loan to pay for all or part of your down payment or to pay off higher cost debt and actually improve your debt-to-income ratio.

Use ourMORTGAGE QUALIFICATION CALCULATORto determine the loan you can afford based on your monthly income and debt

For example, if you have a credit card account with a $15,000 balance and a $500 monthly payment, you could use a retirement account loan to pay off the account. In this scenario, you eliminate a $500 monthly credit card payment, which significantly increases the mortgage you can afford.

In fact, reducing your debt expense is one of the best things you can do to increase the mortgage you are eligible for. From the standpoint of qualifying for a mortgage, the benefit of using a retirement account loan to pay down debt is that no additional payment is included in your debt-to-income ratio.

Guidelines for using a retirement account loan to buy a home can vary by lender and mortgage program. We recommend that you contact multiple lenders in the table below to confirm their qualification requirements. Shopping lenders is also the best way to save money on your mortgage.

If you want to take out a loan from your retirement account, your first step is to contact your plan administrator to understand the qualification guidelines and loan terms. In most cases you can borrow the lower of 50% of your account balance or $50,000.

The length of a retirement account loan typically depends on how you use the proceeds. For example, if you use the loan to pay down debt, the term is usually five years while if you use the proceeds to pay for the down payment on a home the term may be up to ten or fifteen years. The longer the loan term, the lower the monthly payment.

We should also highlight that if you leave your job for any reason, either voluntarily or because your employment was terminated, you are usually required to repay the retirement account loan in full. If you cannot pay back the loan within one-to-two months, you are required to pay taxes and a penalty.

Review How to Use Your Retirement Account to Buy a Home

Withdrawing funds from a retirement account for a loan or any other purpose is a decision that should not be taken lightly. You could potentially reduce the funds available to you in retirement and you may also be required to pay additional taxes and fees. This is why we recommend that you consult an accountant or retirement specialist before taking any funds out of your account.

If you do go forward with the loan, when you apply for the mortgage, you are required to provide the lender with documentation that outlines the key loan terms including the interest rate, length and monthly payment. If you use the loan for your down payment, you must also provide documentation that verifies that the proceeds were deposited into your bank account.

Additionally, if you intend to use your remaining retirement account balance to satisfy any applicable reserve requirement for the mortgage then the loan amount is subtracted from the value of the account.

Sources

"B3-6-05, Loans Secured by Financial Assets."  Selling Guide: Fannie Mae Single Family.  Fannie Mae, February 5 2020.  Web.