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Home Purchase - Loan Program Follows Hardship Rules


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A participant wants to pay cash for a primary residence that he will live in. He has executed a purchase agreement. For other personal / financial reasons, he wants to not have any mortgage payment. He has enough personal non - 401k plan funds that he can fund the minimum required down payment required by the lender. In order to not have a mortgage payment at all however, he needs to borrow from his 401k account to purchase the home. The plan document requires that loans be made only if they otherwise meet the safe harbor hardship rules. My thinking is that because he has personal funds that exceed the minimum down payment required by the lender, that under the terms of the plan, the loan cannot be approved. Or can it be taken into account that this person has valid reasons that he does not want to have any mortgage payment obligation. Thanks for any thoughts.

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We know the hardship rules are two fold: 1) Whether a hardship exists; and 2) Whether a distribution from the plan is necessary to satisfy the hardship. Each of these criteria have their own safe harbors. Obviously, a purchase of a principal residence is deemed a hardship. Under the 2nd category, whether a distribution from the plan is necessary, would require you to maximize available loans under the plan.

Notice, this would tend to be double speak to say a loan would be available for hardships under category 2 above; because category 2 above already requires you to take an available loan from the plan. Given this, my interpretation for loan availability would be subject to category 1 (whether a hardship exists) and not consider whether it could be satisfied under any other means. With this understand, I would approve the loan.

Of course, this is the best I could do without actually reading the plan.

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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My thinking is that because he has personal funds that exceed the minimum down payment required by the lender, that under the terms of the plan, the loan cannot be approved. Or can it be taken into account that this person has valid reasons that he does not want to have any mortgage payment obligation. Thanks for any thoughts.

I'm guessing that you're questioning whether funds are available from an alternative source.

The short answer is the regs say "© Employer reliance on employee representation. For purposes of paragraph (d)(3)(iv)(B) of this section, an immediate and heavy financial need generally may be treated as not capable of being relieved from other resources that are reasonably available to the employee, if the employer relies upon the employee's representation (made in writing or such other form as may be prescribed by the Commissioner), unless the employer has actual knowledge to the contrary, that the need cannot reasonably be relieved..."

Two key pieces being that you can 1) rely on the employee's representation that they haven't already qualified for a mortgage and 2) that you don't have actual knowledge to the contrary. Merely having cash on hand equal to the required down payment is not the same as qualifying for a mortgage.

Personally, I would reduce the cost of the residence by the amount the employee has saved for the down payment and permit a loan for the rest (subject to the maximum loan limits).

Of course some of it may depend on the plan's exact wording and your interpretation of what it means to "otherwise meet the safe harbor hardship rules". The word "otherwise" begs the question "other than what?"

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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If the plan uses the "other resources" standard, the "other resources" standard applicable to hardship distributions includes ability to borrow from commercial lenders. If that standard is applied, the individul must be unable to get a mortgage loan on reasonable terms as a condition to borrowing from the plan (compare to: has not yet applied for a mortgage loan). However, you have to figure out if the hardship standards of the plan with respect to loans requires use of the statutory standard because the statute does not apply to loans. I am sure that you will find thoughtful, complete, and very well drafted provisions in the plan that explain what was intended by application of the hardship standards.

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The OP said "safe harbor hardship rules." In order to satisfy the safe harbor hardship, the distribution must be because of:

Immediate and heavy financial need. The distribution will be deemed a heavy and immediate need if it is for one of the six allowable reasons (I'm sure we're all familiar with them--I won't enumerate).

The hardship distribution must be necessary to satisfy that need. How do we know? You can use the other piece of "safe harbor" definition of hardships. The distribution is deemed to be necessary if:

1) the amount is not for more than the need (plus grossing up for taxes & penatlies)

2) all loans and distributions under all plans of the employer must be taken first. (Except when a loan itself increases the need)

3) 401(k) deferrals must be suspended for at least at least 6 mos (up to a year for non-Safe Harbor 401(k) plans)

That's it. Though the plan administrator should get verification of the need. There is no mention of other resources the participant might have at his disposal.

Has the plan not stipulated "safe harbor hardship," the discussions above make valid points.

Or, am I all turned around on this?

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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The OP said "safe harbor hardship rules."

...

Or, am I all turned around on this?

D'oh! You're correct.

While regulation paragraph (d)(3)(iv)© gives us the laundry list of alternative sources, the "safe harbor" in (d)(3)(iv)(E) says (and I'm mainly putting this here so we can all refresh ourselves on the exact wording):

"(E) Distribution deemed necessary to satisfy immediate and heavy financial need. A distribution is deemed necessary to satisfy an immediate and heavy financial need of an employee if each of the following requirements are satisfied—

( 1 ) The employee has obtained all other currently available distributions (including distribution of ESOP dividends under section 404(k), but not hardship distributions) and nontaxable (at the time of the loan) loans, under the plan and all other plans maintained by the employer; and

( 2 ) The employee is prohibited, under the terms of the plan or an otherwise legally enforceable agreement, from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least 6 months after receipt of the hardship distribution."

This does raise to me a question for the OP to review. Is the intent of the plan that a person taking a "hardship" loan be suspended from making contributions for 6 months?

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Thanks everyone for your thoughtful responses. The participant wants to consider taking a loan. No hardship w/d is being requested.

Example:

Partic buying house, cost to be $200,000. Partic is pre qualified for a mortgage, lender is requesting 20% down, $40,000. This is hypothetical, but mirrors the participant's situation.

Partic has $175,000 in liquid cash. Partic intends to apply $175K to home purchase. Partic would like to borrow $25K from his 401k account. His desire is to pay cash for the house. He has other reasons he does not want to have a mortgage.

******

Plan does not permit loans, except for the 6 safe harbor hardship reasons.

The crux of the issue (in my mind) is, can the participant borrow the $25K from his account under the circumstances - exactly what is the definition of "down payment."

I say "no" we cannot give him the loan, because he has enough money for the down payment ($40K). He has the ability to secure a traditional mortgage. He does not need the plan loan for the sole act of buying the house. But he does need the plan loan to satisfy his "other" need to not have a mortgage.

So is $200,000 a valid down payment on this house - and therefore "meets" the safe harbor for a distribution (were it a distribution, but again, to be clear, this is a loan). Or are we limited to what a lender will require $40K.

I realize if loans were allowed for any reason, this would not be an isuse. We'd grant him the loan. But he must have a hardship in order for us to grant the loan. And I'm not sure we have that, in this case. If the hardship rules do not define "down payment" (please forgive me for not advance researching that) then what would preclude this participant from asserting that the down payment is in fact $200,000. If anyone has any further thoughts I'd be grateful. Thank you.

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Forgetting about the amount for a moment...the terms of the plan say that a loan can be granted for any of the "safe harbor" hardship reasons only. Does the loan program also restrict the amounts like a hardship? Read the plan carefully to see what exactly the conditions are.

If the guy can produce paperwork that says the down payment for a house is $X and he puts in writing he intends for this to be his principal residence, he has satisfied the safe harbor reason criterion. Done.

Now, he's limited in how much he can take. Unless the loan program or plan say he cannot take more than the need, he is generally limited to the $50,000/50% rule. Done.

Because the "safe harbor" rules are being referenced, and if granting a loan can be extrapolated to being tantamount to a hardship that's paid back, it doesn't matter if they guy has a million bucks in the bank. Safe harbor rules don't care. And neither should you.

Let me ask this: if he asked for a loan for funeral expenses for his mother, would you be asking if he had money in the bank to first cover it?

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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I don't think the "minimum" down payment makes a difference here. He is purchasing a principal residence. He could pay for the house entirely via a hardship (or in this case a loan). There's nothing that says he must only take a little bit and have a mortgage on the rest...

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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If anyone has any further thoughts I'd be grateful.

IMO - You're way overthinking this.

1) The regs on both hardships and plan loans are absolutely silent as to downpayments. You're adding in qualifications that don't exist. The exact wording from the hardship regulation is: "Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments)".

Furthermore, in commercial lending, a downpayment is a minimum amount the borrower must bring to the table. If the borrower wants to pay down more, the bank is not going to object because it reduces the bank's risk. Generally speaking, in banking there's no such thing as a downpayment that is too big.

2) BG's and my exchange this morning concluded that under the hardship safe harbor, you don't have to consider whether or not the employee can get a mortgage instead.

Edit: Question: is there something in your plan document or your SPD that's causing you to use the word "downpayment"? Did that word come from you or from something written that you're trying to comply with? (remember that we don't have your exact plan in hand so you have to tell us if it has language about downpayments)

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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The 401k loan in my example would be for $25,000 (I'm uncertain as to why a prior poster stated the loan limits would be exceeded). That would not violate the $50,000 limit (nor the 50% rule in this case).

The loan disclosure has various checkboxes for "reasons for allowing loans" such as "any" and "hardship reasons only" etc. The "hardship reasons only" is the box that is checked. No more specific details are provided in the loan disclosure. The plan permits hardship withdrawals for hte 6 safe harbor reasons.

Downpayment is a term I was using, not something that was in the plan document.

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The 401k loan in my example would be for $25,000 (I'm uncertain as to why a prior poster stated the loan limits would be exceeded). That would not violate the $50,000 limit (nor the 50% rule in this case).

The loan disclosure has various checkboxes for "reasons for allowing loans" such as "any" and "hardship reasons only" etc. The "hardship reasons only" is the box that is checked. No more specific details are provided in the loan disclosure. The plan permits hardship withdrawals for hte 6 safe harbor reasons.

Downpayment is a term I was using, not something that was in the plan document.

The prior poster said the amount might be too much because you mentioned a down payment of $200,000.

Given the document provisions you stated, I see nothing that would preclude giving this person the loan. Unless there is something in the underlying document that hasn't been shared with the group.

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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