401(k) Loans

Do mortgage lenders look at 401k loans?

If you have a 401(k) and you want to take a mortgage loan, find out if the mortgage lender considers the 401(k) debt during the approval process.

3 min read

When applying for a mortgage loan, the lender will evaluate your debts and income to determine if you are eligible for a loan. You will be required to declare all the incomes you currently earn such as salary, business income, investment income, and retirement income from 401(k) or pension payments. Also, you must declare the debt obligations that you are currently paying. The lender uses this information to determine your ability to handle an extra obligation, in addition to the current debts that you are paying.

Mortgage lenders do look at 401(k) loans during the mortgage application process. The mortgage lender uses the 401(k) loan to determine the value of your 401(k) assets and your current debt obligations. Most lenders do not consider a 401(k) when calculating your debt-to-income ratio, hence the 401(k) loan may not affect your approval for a mortgage loan. However, the lender will deduct the outstanding 401(k) loan from your 401(k) balance to determine the net 401(k) assets.

How 401(k) Affects Mortgage Approval

When you apply for a mortgage loan for a residential or commercial property, the lender will require you to provide information on your credit history, employment history, sources of income, and value of assets. Specifically, the lender is interested in knowing the value of liquid assets to make sure you can afford the mortgage payments and that the assets are sufficient to cover reserve funds for the mortgage principal. For example, if the lender requires a three-month reserve, you must provide proof that you have enough funds to cover the mortgage payments for three months.

If you have a 401(k) account, you can use the accumulated retirement savings as proof of reserves, alongside other asset classes such as savings and checking accounts. However, the lender will only consider 70% of the 401(k) funds when determining the value of funds in the account. The remaining 30% accounts for the taxes you will pay if you were to withdraw the money. Using the 401(k) as proof of reserve does not require you to withdraw the money; instead, the lender wants to know how much money would be available if you withdrew the money to make mortgage payments.

Using 401(k) Loan to Buy a Home

A down payment is one of the biggest up-front costs of buying a home. The mortgage lender requires potential homeowners to raise a down payment as one of the requirements for qualifying for a mortgage loan. The amount you set aside for down payment determines how much a lender will give you, and the loan terms. If you have not accumulated enough savings to cover the down payment, you can tap into your 401(k) retirement funds.

The plan administrator may allow you to borrow against your savings to pay down payment for the house. Most 401(k) plans allow participants to borrow up to 50% of their 401(k) vested balance. For example, if you have an $80,000 vested balance in your 401(k), you could borrow up to $40,000. Before releasing the funds, the plan administrator may require you to provide a sales contract of what the funds will be used for. Also, the mortgage lender may require you to provide the 401(k) loan documentation, the amount of loan borrowed, and the terms of the loan. The lender may also want to see proof that the funds were transferred to your checking or savings account so that the funds are ready at loan closing.

Does 401(k) Loan Affect Debt to Income Ratio?

The debt-to-income ratio is one of the key metrics that mortgage lenders consider during the mortgage approval process. The debt-to-income (DTI) ratio is the portion of your income that is spent in making debt payments. A high DTI ratio shows that you have too much debt against your gross income, and that you are more likely to default on a mortgage loan. Conversely, a low DTI shows you have a good balance between income and debt, and you can manage debt payments effectively.

Although a 401(k) is a debt obligation, most lenders do not consider this obligation when determining your debt-to-income ratio. 401(k) loan payments are not treated the same way as a personal loan payment or student loan payment. Therefore, if you have a low DTI, it is unlikely that your 401(k) will increase this ratio. For example, if your gross income is $7,000 and you are currently paying $3,000 in personal loan debts and $1,000 in 401(k) loan payments, your DTI ratio will be 42.8% ($3,000/$7,000). The ratio calculation excludes the 401(k) loan payment. Usually, a DTI ratio above 50% is considered risky, and you might find it difficult to get approved for a mortgage loan.