Behind on the Mortgage? Options to Weigh Before Tapping a 401(k)

When a mortgage payment starts to slip out of reach, a retirement account can look like the nearest source of cash. Before using it, many households find it useful to know what the account's rules and costs are, and what help is available from the loan servicer and housing counselors. This article lays out those pieces. It does not suggest that any option is right for a particular household.

Key takeaways

• A mortgage servicer may offer options such as a repayment plan, forbearance or a loan modification, and the Consumer Financial Protection Bureau advises calling the servicer right away.
• HUD funds free or very low-cost housing counseling nationwide, and no one needs to pay a fee for foreclosure prevention help.
• A 401(k) hardship distribution is optional for a plan to offer, is taxable income, may carry a 10 percent additional tax, and cannot be repaid or rolled over.
• A 401(k) plan loan is a different arrangement that is repaid to the account, but an unpaid balance can be treated as a taxable distribution.
• In a hypothetical comparison, a 9,000 dollar withdrawal could leave roughly 6,120 dollars after federal tax and the additional tax, before state taxes.

Start with the people who can change the loan

The Consumer Financial Protection Bureau advises calling the mortgage servicer right away if you expect to miss a payment. Be ready to explain why, whether the problem is temporary or permanent, and what your income, expenses and savings look like. The servicer then tells you which options, if any, it can offer. The CFPB lists possibilities including a loan modification, a repayment plan, forbearance, refinancing, a short sale or a deed in lieu of foreclosure.

The U.S. Department of Housing and Urban Development also suggests contacting the lender or servicer directly, and says it funds free or very low-cost housing counseling nationwide. Counselors can help people understand their options, organize their finances and, if needed, negotiate with the lender. Both agencies warn about scams: requests for up-front fees, guarantees that you will keep your home, and advice to stop paying the mortgage are warning signs.

What a hardship distribution is

According to the Internal Revenue Service, a retirement plan may allow hardship distributions, but plans are not required to. The need has to be immediate and heavy, and the amount limited to what the need requires. The IRS lists payments to prevent eviction from, or foreclosure on, a principal residence among the expenses it treats as meeting that test. The employer decides what the plan allows and may rely on the employee's written statement.

Three features deserve attention:

• Hardship distributions are subject to income tax, unless they consist of Roth contributions.
• They may also be subject to a 10 percent additional tax on early distributions, which the IRS describes in its tax topic on early distributions from retirement plans.
• They cannot be repaid to the plan or rolled over to another plan or an IRA.

A plan loan is something different

A plan loan is borrowed from the account and repaid to it. The IRS says loans are not taxable if they meet the plan loan rules, and that repayment generally takes place within five years, with payments at least quarterly, though a loan for a principal residence purchase can run longer. If a loan is not repaid, the unpaid balance is generally treated as a taxable distribution. Some plans offer loans and not hardship withdrawals, or the reverse, so the plan document matters.

A rough picture of the cost

Suppose a household needs $9,000 to bring its mortgage current and takes that amount as a hardship withdrawal before age 59 and a half, with no exception to the additional tax. Assume a 22 percent federal marginal tax rate. Income tax would be about $1,980 and the additional tax $900, a total of $2,880. That leaves roughly $6,120 of the $9,000, before state taxes.

The retirement balance would also be $9,000 lower, with no way to put it back and no future growth on it. The example is an illustration. It ignores state taxes, plan fees, how much is withheld and whether any exception applies.

Questions to ask first

1. Have I called the servicer, explained the situation and asked about every available option?
2. Have I spoken with a HUD-approved housing counselor?
3. Is the problem temporary, or would a one-time payment only delay a larger one?
4. Does my plan offer a hardship distribution or a loan, and what documents does it require?
5. What would the tax and any additional tax cost, and what would a tax professional say?
6. What would I be giving up in retirement savings?

Working through these questions can put a retirement account in context. In some cases it remains one option among several, and in others the earlier steps change the picture.

Common questions

Can I use my 401(k) to stop a foreclosure?

Some plans allow a hardship distribution for payments needed to prevent foreclosure on a primary home, but plans are not required to offer it. The money is generally taxable, may carry an additional tax, and cannot be put back, so many people first explore options with their servicer and a housing counselor.

Who can help me if I fall behind on my mortgage?

The Consumer Financial Protection Bureau advises calling your mortgage servicer right away and contacting a HUD-approved housing counselor. HUD says foreclosure prevention help does not require a fee, and it warns about firms that charge for it.

What is the difference between a 401(k) hardship withdrawal and a loan?

A hardship withdrawal is a distribution that is not repaid and is generally taxed. A plan loan is repaid to your own account on a schedule, and the IRS says an unpaid loan can be treated as a taxable distribution.

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