401Ks and the Debt-to-income Ratio for FHA Loans

June 28, 2013

Here’s a not-so-common question about FHA loans, but one that’s important for many borrowers considering their options in this area:

“I borrowed funds from a 401(k) to refinance my home. My lender says this monthly payment would be counted when computing my debt to income ratio. According to the FHA, the following list of financial obligations should not be used to calculate the debt to income ratio: other retirement contributions, such as 401(k) accounts (including repayment of debt secured by these funds). Do these rules still apply?”

The FHA does maintain a set of guidelines on how the lender should view a 401K when it comes to calculating the debt-to-income ratio. According to the FHA loan rules found in HUD 4155.1:

“Obligations not considered debt, and therefore not subtracted from gross income, include:

- Federal, state, and local taxes
- Federal Insurance Contributions Act (FICA) or other retirement contributions, such as 401(k) accounts (including repayment of debt secured by these funds)”

The rulebook also says the following: “Up to 60% of the value of assets such as Individual Retirement Accounts (IRA), thrift savings plans, 401(k) and Keogh accounts may be included in the underwriting analysis, unless the borrower provides conclusive evidence that a higher percentage may be withdrawn, after subtracting any

- Federal income tax, and
- Withdrawal penalties.”

FHA loan rules say redemption evidence is required by the lender, and the portion of the 401K not used to meet closing requirements can be considered cash reserves.

The portion of the question worth paying special attention to concerns paying back the money withdrawn from the 401K. The lender may be interpreting the new need to pay back the funds to her 401K as a recurring debt. In these cases, ask as early as possible about lender standards in situations like these. A participating FHA lender may have more strict standards in such areas than the FHA minimums or basic guidelines as mentioned in the rules printed here.

FHA loan rules included minimum requirements and standards, but in many cases the lender may have higher requirements than the FHA minimum. This is permitted by FHA loan rules as long as such requirements meet Fair Housing standards, but in general credit and debt-to-income regulations set by the FHA may not be the final word on the matter. The lender’s own requirements also play a role. Talk to your loan officer to learn more about the lender’s requirements in this area.