Consider this: You’re ready to buy a house. You’ve even saved up enough to put 20% down on the $100,000 home you found. You tell your banker that you can use $20,000 from your retirement account for the purchase. But when you look at the approval amount, you see that only $12,000 of your retirement account is being used toward your down payment and closing costs – and you were only approved for a $60,000 home. What the heck?
You might not know that we can’t always use the full amount of the assets you provide. The percentage of your assets that we don’t use in our calculations is commonly called a haircut.
What Is a Haircut?
A haircut on your assets is the percentage of the asset’s value that a mortgage company can’t include in their calculations. The total percentage excluded from your assets differs based on the type of loan you’re getting and the type of asset you’re using.
Why Are Haircuts Made?
Haircuts account for the taxes and fees you might pay to use the funds from your asset. Haircuts guarantee that the amount you plan to use for your down payment and closing costs is reflective of how much you can actually get from that asset.
It’s important to note that the amount of the haircut is fairly standard across the mortgage industry. In other words, you won’t be able to get more from your retirement account by choosing a different lender.
What Assets Will Have a Haircut?
Mortgage companies will sometimes only use 60% of your retirement account funds in their calculations, depending on the type of loan you’re getting, due to the tax implications or penalties for taking money out of your retirement savings early. Another reason for the cut is to account for fluctuations in market value. Retirement accounts are usually invested in stocks and mutual funds, so the value that you have in the account may be slightly different from the day you apply to the day you take the funds out.
If you have a Roth IRA, you may be able to use the money without taking a haircut or paying taxes depending on your age and how long you’ve had the account open. However, any interest you’ve earned from the account may be subject to taxes.
Pending Home Sale Proceeds
If you’re selling your current home and don’t yet have a buyer, your mortgage company will cut 10% from the listing price to account for costs like real estate agent fees and anything the buyer may negotiate. So when we’re calculating the amount you can use from the sale of your current home, we’ll subtract your current mortgage balance from 90% of the listing price of your home.
On the other hand, if you already have a signed purchase agreement on your home, we’ll subtract your current mortgage balance and closing costs from the full agreed-upon purchase price to determine the amount you can use from the sale of your home.
What Assets Can Be Used Without Haircuts?
Checking Account, Savings Account and Gift Funds
Checking account funds, savings account funds and gift funds received from family members can usually be used without a haircut. So if you want to use $20,000 from your checking account, we’ll calculate your mortgage options using the full $20,000.
Money Market Accounts
Money market accounts can also be used without a haircut; however, if the account is part of your IRA, it would be subject to the same haircut as your IRA.
Stocks, Bonds and Mutual Funds
You can often use stocks, bonds and mutual funds haircut free; however, you’ll want to have more money in the account than you plan to use. Depending on the type of loan you’re getting, we may need proof that you’ve liquidated those funds if the account has less than 120% of the amount you plan to use from it. For example, if you want to use $10,000 from your bond to buy a home, you’d want at least $12,000 in the bond. The reason for this rule is that market values fluctuate daily. Until the account is liquidated, you won’t know the true value.
What Do Haircuts Mean for Your Mortgage?
It’s important to know how much you actually have to put toward your down payment and closing costs. It also might be helpful to talk to a financial advisor when you’re deciding what assets to use. You might think you can put $20,000 down, but the reality may be different if your assets require a haircut. Understanding these haircuts can help you avoid disappointment in the home price you can get approved for.
Ready to buy a home now? Try Rocket Mortgage if you want to explore your options on your own time, or give us a call at (800) 654-0068 if you want to talk to a Home Loan Expert.
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