Tapping Investments For Homeownership Down Payments

Reports before Davos suggested that President Trump would announce an initiative to spur homeownership by allowing individuals to withdraw funds from their 401(k) accounts to make a down payment on a home purchase without incurring a10% early withdrawal penalty.

Davos has come and gone, and we are now hearing reports that the President is “not a fan” of this approach. His comments seem to echo criticisms from some that we should not encourage individuals to withdraw money from their retirement accounts.

There is merit to this criticism – but also merit to the idea in the first place, since a home purchase has historically proven to be as good a mechanism as retirement plans for wealth building.  Regardless, it just makes sense to explore ways to develop new sources of down payments to increase homeownership.

In November, a National Association of Realtors Release revealed two sobering statistics.  First, “the typical age of first-time buyers climbed to an all-time high of 40 years.”  And second, “the share of first-time home buyers dropped to a record low of 21%.” 

Down payment requirements are generally the biggest barrier to entry-level ownership.  For example, as the OCC has concluded, “For first-time buyers, a major challenge is coming up with a down payment, which can be exacerbated by rising home prices.”  [Office of Comptroller of the Currency On Point 9/24]. 

So, what should we do?  If there are concerns about depleting individuals’ retirement accounts, there is a simple way to have the best of all worlds.  Individuals can borrow from their 401(k) to make a down payment on a home purchase.  But the rules governing this practice are too restrictive.

The maximum repayment term on a 401(k) loan to make a down payment on a home is 15 years.  This should be increased to 30 years (subject to a repayment requirement upon sale or refinance).   

Department of Labor (DOL) rules require that the loan must “bear a reasonable rate of interest,” in order to prevent backdoor tax-free distributions.  This rule is generally interpreted to be prime plus 1% to 2%, .  which currently comes to 7.75% to 8.85%. This is too high for a loan for down payment use.  The rules should be modified to allow a rate as low as the mortgage rate on the loan for the home being purchased.  

But the biggest impediment to an individual borrowing from their 401(k) for a down payment on a home is the risk of losing your job or moving on to a new job.  Most 401(k) plans require you to pay off the loan when that happens. This creates a big financial risk to the homebuyer if they can’t come up with the funds to restore them to the retirement account.

If a person keeps their 401(k) account in the company plan after they leave a job, the plan should not be allowed to require a repayment of the loan upon job termination (unless the home is sold or refinanced).

We should also think outside the box in facilitating other sources of down payment funds.   

Last August, the Community Home Lenders of America (CHLA) unveiled a proposal for a Starker Exchange for Homeownership.  The idea is simple.  Significant amounts of funds are tied up in stocks, mutual funds, and REITs with a taxable gain, and held by the parents and grandparents of young families and individuals struggling to accumulate the funds to buy a home.

The CHLA proposal would allow a deferral of a long-term capital gain on a sale of up to $50,000 in stocks, bonds, mutual funds, or publicly traded REITs – if the funds are gifted to a child or grandchild that uses the funds within 6 months as a down payment on a first-time home purchase.     

Would our proposal be costly?  It could, if not done in a targeted manner – but the proposal can be scaled and targeted to address budget concerns.  Put a lifetime cap on the permissible amount, limit it to first-time homebuyers, cap the home purchase price at the FHA loan limit, and structure it not as a capital gain exclusion but as a deferral (by reducing the basis of the new home purchase).  Mutual fund capital gains distributions should not be eligible, as these are not voluntary sales by the taxpayer.

From a budgetary standpoint, because it does not rely on tax dollars but just taps into existing privately held assets, the federal subsidy cost per home purchase is much lower than, say, the amounts taxpayers spend each year on CDBG and HOME grants that are used as 100% subsidies for home purchase down payments. 

The simple truth is that for individuals – particularly senior citizens – there is a significant possibility that the capital gain an individual would incur if incentivized by our plan would otherwise never be taxed.  Without this new tax incentive, it is highly likely the gain would not take place now, and assuming the person dies with at least that level of gains, they would get the capital gains step-up at death.

We have seen a historical intergenerational transfer of wealth – from younger families to older ones – as home prices and stock prices have exploded.  Because of tax code dis-incentives to sell, these gains are to some extent locked up.  

Why not open them up to help the younger generation – a person’s children or grandchildren?

Finally, we would note there is talk of eliminating the capital gains for home sales of a principal residence (currently there is a $250,000/$500,000 exclusion).  Anything that helps housing is potentially a good thing.  But notably, this does not promote homeownership.  So, a better approach might be to extend our proposal for a Starker exchange to capital gains on a principal home over these exemption thresholds.

Our homeownership challenges are significant.  It’s time to be bold.  

And maybe a few years, we can read a Realtors report that the average age of a first time homebuyer actually went down!

Scott Olson is the Executive Director of the Community Home Lenders of America (CHLA).
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners. To contact the editor responsible for this piece: zeb@hwmedia.com.