A possible foreclosure defense tool

The threat of foreclosure affects an estimated 2 million or more homeowners in the country, but the financial foreclosure defense tool is somehow missing from distressed homeowner’s arsenal.
The Obama administration has been exploring options: a new refi program, which is expected later this month and other programs, that failed. A new concept has surfaced recently on Capitol Hill, which might be the answer for many troubled homeowners with no revenue cost for the government: amend the tax code to allow homeowners who have 401(k) retirement plans to pull out money to save their houses from foreclosure without the usual tax penalties, the Real Deal reported.
What this mean: Under current rules, anyone making what’s known as a “hardship” early withdrawal of funds from their 401(k) must pay the IRS a 10 percent penalty on top of ordinary income taxes. A new bill introduced Oct. 5 would waive the penalty if the purpose of the distribution is to make loan payments to avoid loss of a primary home to foreclosure. In 2011, about 60% of American households nearing retirement age have 401(k)-type accounts, the Wall Street Journal reported in February.
The spark came from Georgia, where Sen. Johnny Isakson and Rep. Tom Graves co-authored the bill, which would allow a withdrawal up to $50,000. The money could be used in a lump sum to pay down the delinquent mortgage balance, or it can be used as part of loan modification agreements with lenders to avert foreclosure. One of the criteria is that the money should be spent within 120 days of receipt and could not exceed 50% of the current amount of funds in the retirement account.
Titled the HOME Act, the proposal sheds light on the potential foreclosure defense resources connected with tapping employee pension accounts. Many, but not all, 401(k) plans allow for loans to participants, including for housing-related purposes. Retirement advisers generally recommend taking a loan from a plan because the money withdrawn is not taxed or penalized. Borrowers are required to pay interest on the loan, but in effect they are paying it to themselves to offset the earnings forgone on the balances taken out, the Real Deal notes.
This plan improves the mechanism of 401(k) plans, as many of them offer hardship withdrawals. But there are multiple issues with this type of withdrawals: first there are the rules – much stricter than the prosed bill’s –, secondly, fewer eligible uses, and third the tax penalties.
Isackson and Graves proposed this bill, arguing with the 10% penalty, which discourages potential users, as avoiding foreclosure is one of the permitted hardship uses under the code. Their bill would remove that disincentive and provide an emergency escape hatch for owners sliding fast toward foreclosure.