Reports before Davos suggested that President Trump would announce an initiative to boost homeownership by allowing individuals to withdraw money from their 401(k) accounts to make a down payment on a home purchase without a 10% early withdrawal penalty.
Davos has come and gone, and we now hear reports that the president is “not a fan” of this approach. His comments appear to reflect criticism from some that we should not encourage individuals to withdraw money from their retirement accounts.
There is merit in this criticism – but also in the idea in the first place, as purchasing a home has historically proven to be as good a mechanism as pension plans for building wealth. Either way, it just makes sense to explore ways to develop new down payment sources to increase homeownership.
In November a Release from the National Association of Realtors revealed two sobering statistics. First, “the typical age of starters rose to a record high of 40.” And secondly, “TThe share of first-time buyers on the housing market fell to a record low of 21%.”
Down payment requirements are generally the biggest barrier to first-time ownership. For example, as the OCC has concluded, “For first-time buyers, making a down payment is a major challenge, which can be exacerbated by rising house prices.” [Office of Comptroller of the Currency On Point 9/24].
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 when purchasing a home. But the rules for this practice are too restrictive.
The maximum repayment term on a 401(k) loan for making a down payment on a home is 15 years. This should be increased to 30 years (subject to a repayment requirement upon sale or refinancing).
Department of Labor (DOL) rules require that the loan “bear a reasonable interest rate” to avoid tax-free backdoor benefits. This rule is generally interpreted as a prime number plus 1% to 2%, . which currently amounts to 7.75% to 8.85%. This is too high for a loan with a down payment. The rules should be adjusted to allow an interest rate as low as the mortgage interest rate on the loan for the home being purchased.
But the biggest barrier 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 major financial risk for the home buyer if they cannot obtain the funds to put it back into the retirement account.
If a person keeps their 401(k) account in the business plan after he or she leaves a job, the plan may not require repayment of the loan upon termination of the job (unless the home is sold or refinanced).
We also need to think outside the box when facilitating other sources of down payments.
Last August the Community Home Lenders of America (CHLA) has unveiled a proposal for a Starker Exchange for Home Ownership. The idea is simple. Significant amounts of money are tied up in stocks, mutual funds and REITs with a taxable gain, and are held by the parents and grandparents of young families and individuals who are struggling to raise the money 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 worth of stocks, bonds, mutual funds or publicly traded REITs – if the money is gifted to a child or grandchild who uses the money as a down payment for a first home purchase within six months.
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. Place a lifetime limit on the amount allowed, limit it to first-time home buyers, limit the purchase price of a home to the FHA loan limit, and structure this not as a capital gains exclusion but as a deferral (by reducing the basis of the purchase of a new home). Distributions of capital gains from mutual funds should not qualify as these are not voluntary sales by the taxpayer.
From a budget perspective, the federal subsidy cost per home purchase is much lower than, for example, the amounts taxpayers spend each year on CDBG and HOME subsidies, which are used as 100% down payment subsidies for home purchases, because they do not rely on taxpayer money but merely leverage existing private assets.
The simple truth is that for individuals – especially seniors – there is a significant opportunity that the capital gains an individual would realize if incentivized by our plan would otherwise never be taxed. Without this new tax incentive, it is very likely that the gain would not happen now, and assuming the person dies with at least that level of gain, he or she would receive a capital gains increase upon death.
We have seen a historic intergenerational transfer of wealth – from younger families to older ones – as home prices and stock prices explode. Because tax laws discourage sales incentives, these profits remain hidden to some extent.
Why not open them up to help the younger generation – someone’s children or grandchildren?
Finally, we note that there is a capital gain elimination on the sale of a primary residence (currently there is a $250,000/$500,000 exclusion). Anything that helps housing is potentially a good thing. But surprisingly, this does not promote homeownership. Thus, a better approach might be to extend our Starker exchange proposal to capital gains on a primary residence above these exemption thresholds.
Our homeownership challenges are significant. It’s time to be brave.
And maybe in a few years we could read a report from real estate agents that the average age of a first home buyer has actually dropped!
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 staff and its owners. To contact the editor responsible for this piece: [email protected].
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