How to Use Retirement Savings to Buy a House

by Abby Hayes

in Mortgages

Photo: kenteegarden

Today’s low interest rates make buying a home incredibly tempting, especially if you’re being hit with annual increases in rent. But finding money for a down payment can be tough, especially if you don’t have much wiggle room in your budget.

One option is to tap your retirement savings. This approach has plenty of pros and cons, and you’ll want to consider it carefully before moving forward. If you do decide to use retirement savings to buy a home, be sure you understand all the rules, regulations and fees first.

Another Option to Consider

Before you cash out retirement savings to buy a home, consider one option: halting your monthly retirement savings in order to save for a home.

This option will keep you from paying penalties and fees for an early withdrawal and will keep your retirement savings intact. If you’re putting a significant amount of money into retirement savings each month and can wait a while before buying a home, this is probably your best bet.

But if you’re not putting much into retirement, or if you started saving young so that you have extra money available in your retirement account(s), read on to find out how to use it for a down payment.

Pros and Cons of Tapping Retirement Accounts

First, you should know that the choice to use retirement funds for buying a home is personal. Whether this is the best option for you depends on your retirement savings, your financial goals and your homebuying situation.

This basic list of pros and cons can help you begin to think through this decision, but you may want to talk to a financial professional who can give you a more thorough evaluation of your options based on your unique circumstances.

Pros

  • You can buy a home more quickly. If you’d need months or even years to save a proper down payment, using retirement can get you into a home — and out of an expensive rental — faster.
  • The money is relatively easy to access. Depending on your employer and the type of retirement account you use, the money in your retirement fund is probably pretty easy to get to, especially if you’re using it to buy a home.
  • If you take out a loan, you’ll repay yourself. If you take a loan against your retirement account for your down payment, you’d pay yourself back, usually at a pretty low interest rate.

Cons

  • Obviously, your retirement savings could take a significant hit, which is made worse when you look at the compounding interest you would have gained on that savings.
  • If you take out a loan against your retirement account and lose your job, you may have to pay back the loan immediately.
  • You may be hit with a serious tax bill if you don’t take your withdrawal properly, and sometimes you won’t be able to avoid taxes, even if you do take the money out correctly.

Using Money from a 401(k)

If you have a 401(k) account through your employer, you’ll need to talk with your human resources department about your options. Generally, you can use one of two options: a loan from your account or a hardship distribution.

Loan from Your 401(k)

Lending rules for 401(k) plans differ from one plan to the next, but many allow you to borrow from your plan. Check your plan documents to see if loans are permitted (or ask your human resources representative).

Usually, you can borrow up to half of your vested account balance, up to $50,000.

When you borrow from your 401(k), you’ll have to make repayments with interest, usually 1-2 percent, depending on your plan. Your repayments go back into your account, beefing your retirement savings back up.

Your 401(k) loan has to be repaid within five years, so you’re not missing that much time and compounded interest in the grand scheme of things, especially if you’re relatively young. The repayment will be done through level payments at least once a quarter for the life of the loan.

As noted above, the riskiest piece of a 401(k) loan is that it may have to be paid in full within 60 days if you quit or lose your job. No job is bulletproof, and if yours is unstable, you may want to avoid this option.

Hardship Distribution

Some 401(k) plans (again, check with your human resources department on your particular plan) allow hardship distributions. These are limited to the elective deferrals in your account and don’t usually include any interest income. This means that unless you’ve been saving a lot or for a long time, there’s probably not that much money available for this type of distribution.

However, if you have an immediate and heavy financial need related to buying a principal residence (i.e., your first and primary home), you may be eligible for a hardship withdrawal.

Also, you’re not eligible for a hardship distribution if you can cover a down payment by liquidating other assets, taking other nontaxable loans or distributions from the account, or ceasing elective contributions to your plan. Basically, to take a hardship distribution, you have to prove it’s your only option for putting a reasonable down payment on a home.

A hardship distribution from your 401(k) will still require that you pay taxes at the ordinary income rate, because the money wasn’t taxed before it went into your account. But you won’t have to pay the extra penalty associated with early withdrawals.

Clearly, this is a last-ditch option for tapping into your 401(k) account, and it may also involve lots of extra paperwork and scrutiny. Still, it’s there if you really need it.

Using Money from an IRA

If you qualify as a first-time homebuyer, you can take up to $10,000 out of your IRA account to pay for the down payment and/or closing costs to buy, build or rebuild a home. You’ll still have to pay taxes on any pretax IRA investments (i.e., those in a traditional, rather than a Roth, IRA), but there won’t be a 10 percent early withdrawal penalty to worry about.

You can use money in an IRA to pay first-time home acquisition costs for yourself, your spouse, your or your spouse’s child, your or your spouse’s grandchild, your or your spouse’s grandparent or another ancestor. (In other words, if someone wants to give you a down payment gift, they can use up to $10,000 of an IRA to do so, as long as you’re a first-time homebuyer.)

Under IRS rules, a first-time homebuyer is anyone who hasn’t owned a home within the last two years. So, really, this could be your second or third home, as long as you’ve not owned a home within the past two years. Your spouse also needs to qualify under this rule if you’re buying a home together.

Also note: if you’re eligible for a 401(k) distribution, say you left a job with a company 401(k), you could roll the money into an IRA and then use it for a down payment to avoid extra fees and penalties. This involves an extra step but is usually better than straight-up taking the money from your eligible 401(k).

Which is Right for You?

As you can see, withdrawing from an IRA, because it has the built-in first-time homebuyer provision, is usually the best option, if you have an IRA available to you. But if you’re only working with an employer 401(k), you’ll need to talk to your employer about the possibilities.

Remember that you may need to talk to a financial planning professional about your options. In the long run, waiting to buy a home in favor of leaving your retirement funds intact could be a better option. It all depends on your current financial circumstances and your eventual financial goals.

IRS Resources

401(k) Withdrawal Rules

IRA Withdrawal Rules

Rolling Over a 401(k)

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Your 60-Second Guide to Credit Cards

by Abby Hayes

in Credit Cards

60 SecondsPhoto: wwarby

Are you completely new to the world of credit cards? Interest rates. Cash back bonuses. Credit limits. It can all be quite confusing! This quick credit card guide will get you started in understanding all the credit card basics:

Credit Card Pros and Cons

As with all other financial products, credit cards have their pros and cons. And they’re not necessarily the best choice for everyone. Here are some of the things to consider before you decide to get a credit card:

Pros

  • They build credit history. Credit cards, particularly easy-to-get secured credit cards, are a great way to build credit history. You can certainly live without credit cards, but without credit history, you won’t be able to get more important loans for things like a car or a home.
  • They can act as a safety net. If you don’t have an emergency fund or are just starting to build yours, a credit card can be a decent safety net in the meantime.
  • They offer fraud and purchase protection. You’re legally protected from paying for fraudulent credit card purchases made in your name. But the protection doesn’t end there. Many cards offer warranties or purchase protections, and some also offer travel and rental car insurance (as long as you purchase the guaranteed/insured items with your card, of course).
  • They may offer great rewards. Some credit cards offer great cash-back or point-building rewards that can really save you money on things you use every day.
  • You can use them to buy now and pay later. The whole point of a credit card is that you can buy something now and pay for it later. Used wisely, this is a great way to juggle monthly finances or to buy big-ticket items without saving up to a long time first.

Cons

  • They charge high interest rates. Credit cards have some of the highest interest rates of any loans around. If you don’t pay off your balance in full each month, you could get stuck paying a lot of extra money on basic purchases.
  • The minimum payments won’t get you far. Credit card minimum payments are actually designed to keep you in debt – and paying interest – as long as possible. You’ll have to pay more than the minimums if you want to get out of debt.
  • They may charge other high fees. Credit card fees are pretty much at the discretion of their respective companies, so you may get charged extra interest or outrageous fees for balance transfers, cash withdrawals, late payments, and more.
  • Credit cards let you spend more irresponsibly. When you have credit available, it’s tempting to make irresponsible purchases, which can cost you dearly in the long run.

Essential Credit Card Terminology

Before you can choose a credit card that works for you, you’ve got to understand the basic terminology. Understanding what a credit card issuer means when it says “APR” or “annual fee” will give you a better grasp on credit card basics:

  • Annual fee: Many credit cards come with a once-a-year fee to own the credit card. Some cards have no annual fees, but, often times, those with the best rewards or interest rates do have fees.
  • Annual Percentage Rate (APR): This is the annual interest charged on outstanding credit card balances.
  • Introductory rate: Many cards charge a lower interest rate for the first few months that you own the card. Be sure you know how long the introductory rate will last, and what the APR will be after that introductory period.
  • Balance: This is the amount of money that you owe on your credit purchases.
  • Credit line/limit: This is the maximum amount you can charge to a specific credit card account. (Some cards won’t allow you to charge more than your credit line, and others will just charge you extra fees if you go over the limit.)
  • Available credit: This is the difference between your credit card balance and your credit limit. (ie. If your limit is $3,000 and your balance is $2,000, your available credit is $1,000.)
  • Minimum payment: This is the minimum amount you’ll have to pay on your credit card to keep the account in good standing. Due to recent legislation, your credit card statement will show you how long it would take to pay off the balance making only minimum payments.
  • Overdraft protection: Some banks let you link a checking account to your credit card, so if you bounce a check from your checking account, the excess will be charged to your credit card. This can shield you from overdraft penalties and bounced checks.

How Credit Card Interest Works

One of the most important things to understand about credit cards is exactly how interest works. If you don’t pay off your credit card balance every month, you may end up paying a huge amount of interest over time. Interest is charged every month, and it will just keep adding up.

Here’s an example of how credit card interest works:

Let’s say you make a large purchase and charge $3,000 on a card with an 18% interest rate. Making minimum payments of interest plus 1% of your balance, it will take you 222 months (18.5 years!) to pay off your balance. In that time, you’ll pay $3,923 in interest – more than doubling the original charge.

As you can see, credit card interest can really work against you, even if you make slightly more than minimum payments.

The Basics of Choosing a Credit Card

Choosing a credit card is all about figuring out 1) what credit card companies might offer you and 2) what works best for you.

The first – what credit card companies may offer you – is largely based on your credit history. If you have bad credit or no credit history, you’re not likely to get a premium card with a low interest rate and killer perks. If you’re just starting out, you may even need to look into prepaid cards.

Deciding what works best for you has a lot to do with what you’re going to use the card for.

If you want to make a balance transfer, check out cards with a 0% balance transfer offer. If you’re going to use the card for a major purchase that you’ll pay off over time, check out cards with lower interest rates. If you’re planning to use the card for everyday purchases, pay it back in full each month, and reap the rewards, a travel rewards card or cash back card may be for you.

The key is to compare credit card offers and interest rates to ensure that you’re getting the best card for your particular financial situation. Many people even keep multiple cards that they use for different types of purchases in order to maximize savings and rewards.

Do’s and Don’ts When Using a Credit Card

A credit card can be a financial tool or a financial trap, depending on how you use it. Here are some do’s and don’ts to help you use your credit card wisely:

  • Do stick to a budget, even when using a credit card. If you’re tempted to live beyond your means by constantly swiping your card, leave it at home.
  • Do plan to make more than minimum payments, even on large purchases. Remember how that interest adds up!
  • Do consider using a card for set expenses that you’ll pay off every month. Paying electric, gas, internet, cable, etc. with a credit card helps ensure you don’t over-spend, since these are all necessary expenses, but lets you reap credit card rewards, at the same time.
  • Do take your time when choosing a credit card, and compare offers to ensure you’re getting the best deal.
  • Do negotiate for a lower interest rate after you’ve proven yourself to be a good customer.
  • Do let your lender know as soon as possible if you won’t be able to make a minimum payment. Many will work with you to come up with an affordable payment plan.
  • Don’t carry a large balance on your credit card, as this will lower your credit score.
  • Don’t forget to check your credit card statement each and every month.

How to Read a Credit Card Statement

The government has recently made credit card companies create easier-to-read statements, which can help you, as a consumer, make better credit decisions. Learning to read this statement can help you make the best possible choices.

The Federal Reserve offers a detailed example of a credit card statement. This is a great example to check out because it shows what should be on a credit card statement, and about where everything will be located on your statement.

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The Best Way to Get Your Credit Score

by Jeffrey Trull

in Credit

The undisputed best way to get your credit report comes from the only source that’s truly free: AnnualCreditReport.com. It’s easy and free because it’s guaranteed by law.

Unfortunately for consumers, getting your credit score is not as easy as obtaining your free credit report. The world of credit scores is still a bit like the Wild West, with many websites offering several forms of your credit score at varying costs.

Finding the best way to get your credit score can be complicated. Here are some popular places to obtain your credit score with a variety of features, costs and the credit scores given.

myFICO.com

The score you’ll get: A FICO score from TransUnion and Equifax.
Costs: $19.95 one-time fee per each score. Paid monthly subscriptions available.

Using the myFICO site to get your credit score takes you directly to the source of the score that’s used by 90 percent of top lenders. myFICO is owned by Fair Isaac, the company responsible for creating the FICO score.

Getting your FICO score from myFICO costs $19.95 for one-time report from a single credit bureau. Equifax and TransUnion scores are available, but myFICO doesn’t sell Experian scores. You can also get your score for free with a 10-day trial of myFICO’s Score Watch.

Equifax

The score you’ll get: An Equifax FICO credit score.

Costs: $19.95 one-time fee. Subscription options for non-FICO scores and other products.

Buried behind several credit monitoring offers that come with a monthly fee, Equifax offers a FICO score. For a one-time $19.95 fee, you’ll get your Equifax FICO score.

A one-time credit score and report from all three bureaus costs $39.95 for non-FICO scores. Equifax offers other credit score subscriptions bundled with other services.

Experian

The score you’ll get: Unlimited access to your Equifax score, with once yearly access to scores from all three credit bureaus. Additional credit features.

Costs: Subscriptions starting at $17.95 per month.

Experian offers the benefit of credit scores once a year from all three credit bureaus with their subscription service. However, the scores are not FICO scores.

For Experian Credit Tracker, which appears to be the primary service Experian is pushing, it’s $1 for a seven-day trial and then $17.95 a month after that. However, while this plan gives unlimited access to an Experian score, it doesn’t include the same for scores from the other two bureaus.

Right now, there’s no way to simply purchase an Experian FICO score. Unless you apply for a loan or can request scores elsewhere, you’re stuck with FICO scores from the other two bureaus or generic Experian Scores.

TransUnion

The score you’ll get: Your TransUnion score with unlimited updates as well as other add-on features.

Cost: Free seven-day trial with credit card required, then $16.95 per month.

TransUnion provides access to your credit score with a free seven-day trial of their TransUnion Credit Monitoring service. A credit card is required for the trial, and you’ll automatically be billed $16.95 per month after the trial period ends. This service doesn’t provide FICO credit scores.

Credit Karma

The score you’ll get: Three scores supplied by TransUnion.
Cost: Free, no credit card required. Contains ads for related services.

Credit Karma offers three credit scores for free. They explain in their FAQ section the three scores that are offered: TransRisk NewAccount Score, VantageScore and Auto Insurance Score, each supplied by TransUnion. The VantageScore model was developed by all three credit bureaus and “introduces the first, consistent scoring methodology shared by all three bureaus.”

In addition to the scores, Credit Karma contains several free tools to assess and improve your credit score. This includes a credit report card, which grades your credit usage and history, as well as free credit monitoring.

In exchange for free scores, you’ll have to put up with some ads, which aren’t very hard to ignore if you’re not interested.

See our Credit Karma review for more information.

Credit.com

The score you’ll get: An Experian Credit Score and VantageScore, plus a FICO score estimate.
Cost: Basic service is free, no credit card required. Ads for other services.

Credit.com is partnered with Experian, and users can get a free Experian credit score along with a VantageScore provided by Experian. While neither of these is a FICO score, Credit.com does estimate the score for you.

As with other free credit score options, Credit.com creates a “soft pull” on your credit report, which will not influence your credit score.

Credit.com’s basic service is free. The site includes offers and rates for other financial products including credit cards and loans.

Quizzle

The score you’ll get: A score based on your Experian credit report.
Cost: Free, with monthly paid plans offered.

Quizzle provides a free credit score based on information on your Experian credit report. This score is called a CE Credit Score, and it’s published by CE Analytics. Quizzle goes on to explain that this score “is considered a consumer score, meaning its sole purpose is to help educate you.”

Quizzle’s basic plan is free, with certain pages and features that will prompt you to sign up for a paid account.

Quizzle offers a variety of plans with an upgraded feature starting at $7 a month that include credit monitoring, trends and analysis of your credit.

Check out our Quizzle review for more.

Credit Sesame

The score you’ll get: An Experian National Equivalency Score.
Cost: Free, with ads for other services.

Credit Sesame uses data from Experian to provide what’s called an Experian National Equivalency Score. So there’s no confusion, Credit Sesame explicitly states in its FAQ section that it’s not a FICO score.

Credit Sesame provides graphical representation of your credit score and usage and compares your scores to your peers. Credit Sesame offers free credit monitoring and loan tracking, too.

Credit Sesame advertises offers for mortgages, auto loans and other financial products.

See our Credit Sesame review for more info.

Free from a lender after being denied the best rates

The score you’ll get: Any credit score that was used to give you other than the best rate.
Cost: Any fees associated with your loan application. No cost for the actual score.

Thanks to the Fair and Accurate Credit Transactions Act of 2003, credit issuers must provide you with a free credit score if you’re offered a loan at any rate other than the best rate.

Technically, they have two options: either provide a borrower with a “risk-based pricing” notice and a credit report or a free credit score. Usually the latter option is given, providing potential borrowers with a score at no charge. You’ll likely receive a FICO score, as most lenders use some variation of this model in lending decisions.

What’s the best way to get your credit score?

As you can see, there are various options when it comes to getting a credit score. But not all options are equal. A few points to consider:

  1. Unless the score you’re buying or accessing says it’s a FICO score, it’s probably not. FICO claims its credit scores are used by 90 percent of the top lenders, so you may end up with the closest thing by choosing a FICO score. If you want your true FICO scores, your only option is to buy from myFICO for Equifax and TransUnion scores and then go directly to Experian for your FICO score there.
  2. Even a FICO score doesn’t necessarily tell you everything you need to know. FICO alone has 49 versions of your score, making it nearly impossible to pin down your true credit score. These scores are calculated for different purposes, and each type is then calculated by the three credit bureaus.
  3. Scores can be drastically different. For example, just from enrolling in these free accounts, I received a credit score of 788 from Credit Sesame, but a 716 from Quizzle. Credit Karma and Credit.com fell in between those two scores.

There is some good news for dealing with all of these scores. The Consumer Financial Protection Bureau released a report in 2012 about credit score. In the report, it says:

The CFPB found that for a majority of consumers the scores produced by different scoring models provided similar information about the relative creditworthiness of the consumers. That is, if a consumer had a good score from one scoring model the consumer likely had a good score on another model.

Knowing your actual credit score might not be as important as understanding you credit report and knowing how to improve your credit score.

If you’re simply looking to check credit scores as a guide rather than pin down an exact number, consider starting with free options like Credit Sesame and Credit Karma. If you’re having trouble with credit or may be applying for a loan soon, think about purchasing your true FICO scores from myFICO.

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