I’m gonna pick up the pieces, And build a Lego house When things go wrong we can knock it down
It's hard to admit a mistake, change course, and pick up the pieces left behind. People who bought in the frenzy of the housing bubble made a mistake. A big one. But rather than short sell or allow the house to be auctioned in foreclosure, people will do nearly anything -- including sacrificing their future -- to avoid admitting the mistake and doing what's necessary to get on with their lives.
The proposed legislation would amend the tax code to allow homeowners who have 401(k) retirement plans to pull out money to save their houses from foreclosure without the usual tax penalties.
IHB: are they saving their homes from foreclosure, or saving the banks from taking a loss at the expense of their retirement?
By Kenneth R. Harney -- October 16, 2011
With hundreds of thousands of homeowners facing imminent foreclosure and estimates of 2 million or more in the wings, are there any financial tools available to distressed borrowers that haven't been tried yet? And is there a way to help owners that won't rack up huge federal expenditures and add to the deficit?
The Obama administration has been exploring options — including a new refinancing program expected this month — but a concept has surfaced on Capitol Hill that might offer modest help with no revenue cost to the government: Amend the tax code to allow homeowners who have 401(k) retirement plans to pull out money to save their houses from foreclosure without the usual tax penalties.
That is a horrible idea. Retirement accounts are supposed to be protected. If you allow loan owners to sacrifice their retirements to save the banks, what we will end up with is millions of people with no retirement savings in order to save the banks. I think that is terrible.
The change would work like this: Under current rules, anyone making what's known as a "hardship" early withdrawal of funds from their 401(k) must pay the IRS a 10% penalty on top of ordinary income taxes. A bill introduced Oct. 5 would waive the penalty if the purpose of the distribution is to make loan payments to avoid loss of a primary home to foreclosure.
Saving the banks is a special hardship now? This proposal makes me particularly angry. A foreclosure would eliminate the hardship, and the loan owners would adjust to life in a rental -- with their retirement savings safely protected.
Co-written by Sen. Johnny Isakson and Rep. Tom Graves, both Republicans from Georgia, the bill would allow owners to pull out up to $50,000. The money could be used in a lump sum to pay down the delinquent mortgage balance or to fill shortfalls caused by reductions of household income.
Using retirement savings to bail out lenders or support a family's current lifestyle is a really bad idea.
It could also be used as part of loan modification agreements with lenders designed to avert a foreclosure. No matter how the money is used to resolve the mortgage delinquency, it would need to be spent within 120 days of receipt and could not exceed 50% of the funds in the retirement account.
Owners would still be subject to income taxes on the amounts withdrawn.
Good. That will likely stop most people from doing it.
Though neither of the co-sponsors assert that the bill would raise revenue — they simply say it won't cost the government anything — some retirement program experts say it might. Edward Ferrigno, vice president for Washington affairs at the Plan Sponsor Council of America, a group that represents employers that offer workers 401(k) accounts, said that by triggering taxable distributions from otherwise untouched, tax-deferred plans, the bill "should generate revenues." Ferrigno declined to comment on the bill overall, pending further review of its provisions.
Titled the HOME Act, short for Hardship Outlays to protect Mortgagee Equity Act,
Protect mortgage equity? These government labels and acronyms are misleading. If these people had any equity in their properties, they could merely sell them and pay off the loan. Nobody with equity needs this money. It's the loan owners who will take the money.
the proposal sheds light on the potential foreclosure-avoidance resources — and the drawbacks — connected with tapping employee retirement accounts. Many, but not all, 401(k) plans allow loans to participants, including for housing-related purposes. Retirement advisors generally recommend taking a loan from a plan because the money withdrawn is not taxed or penalized. Borrowers are required to pay interest on the loan, but in effect they are paying it to themselves to offset any earnings lost on the balances taken out.
Many 401(k) plans also allow "hardship" withdrawals. But these come with much stricter rules and fewer eligible uses, plus the tax penalties. The Internal Revenue Code limits hardship distributions to situations in which there is an immediate and urgent financial need and there are no other funds available to meet this need. On top of that, the rules require that taxpayers must opt first for a loan from the retirement plan — if permitted — before pursuing a hardship withdrawal.
Though avoiding foreclosure is one of the permitted hardship uses under the code, the 10% penalty discourages potential users, Isakson and Graves argue. Their bill would remove that disincentive and provide an emergency escape hatch for owners sliding fast toward foreclosure.
I have a better idea for legislation: remove "avoiding foreclosure" from the list of permitted hardships. Rather than make it easier for people by removing the penalty, we should make it harder for people to waste their retirement money in this manner.
Putting aside the potential positives, are there downsides to making a hardship withdrawal from your 401(k), even penalty-free? You bet. Pulling out 401(k) dollars early — with or without a tax penalty — is still an expensive way to raise money. Not only does it deplete the tax-deferred savings you've set aside, but in the case of hardship withdrawals you are prohibited by IRS rules from making new contributions to your plan for six months.
It is a very expensive way to raise money. When someone takes money out of a retirement account, it isn't just the loss of the money, it's the loss of the growth of that money over time that gets really expensive.
Even if the HOME bill makes it through Congress — and there's no assurance it will — taking the hardship route should never be your first choice. It should be your last resort, when there's nothing else that will save your house and you don't want to walk away.
Most people who would consider this option would be better off if they walked away.
But also consider the retirement plan alternative that may already be buried away in your plan documents: a save-the-house loan to yourself. If the numbers work, and you have a reasonable chance of avoiding foreclosure and repaying the loan, check it out. It just might be your solution.
kenharney@earthlink.net
So what do you think, IHB readers, should loan owners be allowed to take money out of their retirement accounts without penalty to give to the bank?
Short sale caused my HELOC abuse
The owner of today's featured property is selling short despite the small profit on the transaction. If not for the HELOC abuse, this would not be a short sale. Of course, if not for the HELOC abuse, this owner wouldn't have had the pleasure of blowing over $300,000 either.
The property was purchased on 6/8/2003 for $551,000. The owner used a $440,800 first mortgage, a $51,100 second mortgage, and a $51,100 down payment.
On 3/19/2004, only 9 months later, he refinanced with a $502,001 first mortgage and a $60,000 HELOC.
On 4/25/2005 he got a $100,000 HELOC.
On 8/7/2006 he obtained a $700,000 first mortgage and a $87,450 HELOC.
Assuming the final HELOC was maxed out, the total property debt was $787,450, and the mortgage equity withdrawal was $295,550.
$300K in three years. Not bad.
------------------------------------------------------------------------------------------------------------------------------------------- This property is available for sale via the MLS. Please contact Shevy Akason, #01836707 949.769.1599 sales@idealhomebrokers.com
Beds: 4 Baths: 3 Sq. Ft.: 2129 $272/SF Property Type: Residential, Single Family Style: Two Level, Contemporary Year Built: 1976 Community: Woodbridge County: Orange MLS#: S675445 Source: SoCalMLS Status: Active On Redfin: 12 days ------------------------------------------------------------------------------ Fabulous opportunity to own this outstanding home in Woodbridge, 4 bedrooms, 3 baths with one bed and bath downstairs, nice sized back yard, Formal living and dining room, breakfast nook, family room, open and spacious. Just walking distances to all the ammenities that Woodbridge has to offer ------------------------------------------------------------------------------------------------------------------------------------------- Proprietary IHB commentary and analysis
Resale Home Price ...... $579,000 House Purchase Price … $551,000 House Purchase Date .... 6/8/2003
Net Gain (Loss) .......... ($6,740) Percent Change .......... -1.2% Annual Appreciation … 0.6%
Cost of Home Ownership ------------------------------------------------- $579,000 .......... Asking Price $115,800 .......... 20% Down Conventional 4.20% ............... Mortgage Interest Rate $463,200 .......... 30-Year Mortgage $115,067 .......... Income Requirement
-$372 .......... Tax Savings (% of Interest and Property Tax) -$644 .......... Equity Hidden in Payment (Amortization) $174 .......... Lost Income to Down Payment (net of taxes) $92 .......... Maintenance and Replacement Reserves ============================================ $2,223 .......... Monthly Cost of Ownership
Cash Acquisition Demands ------------------------------------------------------------------------------ $5,790 .......... Furnishing and Move In @1% $5,790 .......... Closing Costs @1% $4,632 ............ Interest Points @1% of Loan $115,800 .......... Down Payment ============================================ $132,012 .......... Total Cash Costs $34,000 ............ Emergency Cash Reserves ============================================ $166,012 .......... Total Savings Needed -------------------------------------------------------------------------------------------------------------------------------------------------------
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