Sen. Johnny Isakson (R-GA) and Rep. Tom Graves (R-GA) have introduced a bill enticingly called “The HOME Act” (Hardship Outlays to protect Mortgagee Equity). The bill, which sounds reasonable enough on its surface, would allow homeowners under 59 1/2 withdraw up to the lesser of $50,000 or 50% of their IRA and 401(k) funds to pay principal or interest on their mortgages.
If enacted, the bill would indeed protect “Mortgagee Equity.” Unfortunately, if people understood proper legal terminology, they would know that the Borrower is the Mortgagor. It is the Lender who is the Mortgagee, and it is the Lender’s equity in the mortgage that is being protected!
The primary effect of this bill would be to increase the lenders’ return on investment by giving them an additional tool to pressure harried debtors into raiding their retirement funds, funds that lenders are otherwise unable to reach.
One of the most common mistakes made by people desperately trying to hold onto their homes is to withdraw money from their retirement funds. Your retirement funds cannot be attached by creditors, whether or not you declare bankruptcy. As traumatic as it may be to lose a house to foreclosure, it would be even worse to catch up momentarily, only have the house go into foreclosure down the road after you have blown your retirement nest egg.
There are other ways you may be hurt by applying retirement funds to your mortgage debt. Should you end up declaring bankruptcy, you are allowed to keep (ie., exempt) a portion of the equity in your home. If you pay down your mortgage debt, you may have more equity than the allowed exemption. If that happens, the trustee can force the sale of your home and turn over excess proceeds to your unsecured creditors.
Also, if the amount you owe on your house is greater than its value and you are in a Chapter 13, you may be able to “strip” a second mortgage. If you have a second mortgage and you pay down the first mortgage to the point where the balance you owe is less than the value of the house, you will have destroyed your ability to strip the second mortgage.
Finally, if all this isn’t enough to deter you from raiding your 401(k), think about the fact that even though you may not have to pay the 10% penalty for early withdrawal, whatever you withdraw is still subject to income tax, and income tax obligations are not dischargeable in bankruptcy.