9.1 IRC §72(p) Statutory Loan Limits ($50,000 / 50% Vested Balance Calculation)

9.1 IRC §72(p) Statutory Loan Limits ($50,000 / 50% Vested Balance Calculation)

[!NOTE] The Statutory Default Rule: All Plan Loans Are Taxable Distributions Under the Internal Revenue Code, the baseline statutory rule governing participant loans is restrictive and punitive. Codified at IRC §72(p)(1)(A), the general rule states that if a participant or beneficiary receives any amount directly or indirectly as a loan from a qualified employer plan, or assigns or pledges any portion of their interest in the plan as security, the transaction is treated as a taxable distribution (a deemed distribution) from the plan. A participant loan escapes immediate taxation and early withdrawal penalties only if it satisfies the statutory safe-harbor exception requirements set forth in IRC §72(p)(2).

For retirement plan administrators, recordkeepers, and Third-Party Administrators (TPAs) pursuing the Qualified 401(k) Administrator (QKA) credential, participant loans represent one of the highest-volume, highest-risk operational compliance areas. Understanding the precise mathematical formula under IRC §72(p)(2)(A), the anti-churning lookback rules, and the intersection between the Internal Revenue Code and Title I of ERISA is essential to prevent operational defects that can trigger taxable deemed distributions and prohibited transactions.

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Statutory Scope: Qualified Employer Plans Covered

The statutory loan provisions of IRC §72(p) apply to a specific universe of tax-favored retirement arrangements defined as "qualified employer plans" under IRC §72(p)(4):

• IRC §401(a) Qualified Plans: Defined contribution plans (including 401(k) profit-sharing and money purchase pension plans) and defined benefit pension plans.
• IRC §403(a) Qualified Annuity Plans: Annuity contracts purchased by employers under a qualified annuity plan.
• IRC §403(b) Tax-Sheltered Annuity (TSA) Plans: Plans maintained by public schools and IRC §501(c)(3) tax-exempt organizations.
• IRC §457(b) Eligible Governmental Plans: Deferred compensation plans established and maintained by state and local governments.

Arrangements Excluded from Participant Loans

• Non-Governmental IRC §457(b) Plans: Top-hat deferred compensation plans maintained by tax-exempt non-profits cannot offer participant loans. Trust assets must remain solely the property of the employer subject to general creditors; lending funds to employees violates constructive receipt rules.
• Individual Retirement Accounts (IRAs): Under IRC §408(e)(2), an IRA owner cannot borrow from their IRA. Any loan from an IRA, or the use of an IRA as collateral for an outside loan, constitutes a per se prohibited transaction under IRC §4975(c)(1)(B). The penalty is catastrophic: the IRA ceases to be an IRA as of the first day of the taxable year, and the entire fair market value of the IRA is treated as distributed in a fully taxable distribution subject to ordinary income tax and IRC §72(t) early withdrawal penalties.
• SEP IRAs and SIMPLE IRAs: Because Simplified Employee Pensions (SEPs) under IRC §408(k) and SIMPLE IRAs under IRC §408(p) are funded through individual retirement accounts, they are subject to the absolute IRA loan prohibition. Participant loans are strictly illegal in SEPs and SIMPLE IRAs.

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The Statutory Maximum Loan Formula: IRC §72(p)(2)(A)

Under IRC §72(p)(2)(A), a loan from a qualified employer plan does not trigger immediate taxation as a deemed distribution to the extent that the loan, when added to the outstanding balance of all other loans from the plan, does not exceed the lesser of two statutory caps:

$\text{Maximum Aggregate Loan Amount} = \min\left( \text{Cap 1: The Adjusted \$50,000 Cap}, \text{Cap 2: The Vested Balance Cap} \right)$

+---------------------------------------------------------------------------------------------------+
|                         IRC §72(p)(2)(A) STATUTORY MAXIMUM LOAN FORMULA                           |
+---------------------------------------------------------------------------------------------------+
|                                                │                                                  |
|                    CAP 1                       │                      CAP 2                       |
|          THE ADJUSTED $50,000 CAP              │             THE VESTED BALANCE CAP               |
|                                                │                                                  |
|                 $50,000                        │                  GREATER OF:                     |
|                    -                           │                                                  |
|   Excess (if any) of:                          │   • 50% of the participant's nonforfeitable      |
|   (i)  Highest outstanding loan balance        │     (vested) accrued benefit under the plan,     |
|        during the 1-year period ending on      │     OR                                           |
|        the day before the new loan is made,    │   • $10,000 (if adopted by the written plan      |
|        OVER                                    │     document as a de minimis safe harbor).       |
|   (ii) Current outstanding balance of loans    │                                                  |
|        from the plan on the date of the loan.  │                                                  |
|                                                │                                                  |
+---------------------------------------------------------------------------------------------------+
                                                 │
                                                 ▼
                        MAXIMUM ALLOWABLE AGGREGATE LOAN BALANCE
                                                 │
                                                 ▼
                         LESS: Current Outstanding Loan Balance
                                                 │
                                                 ▼
                            MAXIMUM NEW LOAN BORROWING CAPACITY

Cap 1: The Adjusted $50,000 Cap (The 1-Year Lookback Reduction)

The statutory dollar limit begins at $50,000. However, Congress did not enact a static $50,000 ceiling. To eliminate abusive borrowing patterns, the $50,000 cap must be reduced by the excess (if any) of:

1. The highest outstanding balance of loans from the plan during the 1-year period ending on the day before the date on which such loan was made, over
2. The outstanding balance of loans from the plan on the date on which such loan was made.

$\text{Cap 1} = \$50,000 - \Big( \text{Highest Balance in Prior 365 Days} - \text{Current Outstanding Balance} \Big)$

Cap 2: The Vested Account Balance Cap

The second statutory cap limits borrowing based on the participant's accrued financial stake in the plan. Cap 2 equals the greater of:

• 50% of the present value of the participant's nonforfeitable (vested) accrued benefit under the plan, OR
• $10,000 (an optional statutory de minimis floor permitted by the Code, provided the written plan document authorizes it).

Determining Available New Borrowing Capacity

Once the lesser of Cap 1 and Cap 2 is established, that figure represents the maximum aggregate loan debt the participant may hold. To determine how much the participant can borrow as a new loan today, subtract the current outstanding loan balance:

$\text{New Borrowing Capacity} = \min(\text{Cap 1}, \text{Cap 2}) - \text{Current Outstanding Balance}$

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Deconstructing the 1-Year Lookback Reduction Rule

Why did Congress create the 1-year lookback reduction under the Tax Reform Act of 1986 (TRA '86)?

The Historical Revolving Credit Abuse

Prior to 1986, a participant could borrow the full $50,000 statutory limit for a 5-year term, make amortized payments for four years down to a low balance (or pay off the remaining balance on Day 364), and immediately take a brand-new $50,000 loan on Day 365. By continually churning and replacing loans, participants maintained a perpetual revolving line of credit against their retirement nest egg, permanently draining trust liquidity and violating the fundamental congressional policy that retirement plans exist to accumulate funds for post-career support.

How the Lookback Rule Works Mechanically

The lookback rule prevents revolving loans by penalizing loan payoffs made within the preceding 12 months. The lookback reduction amount is exactly equal to the principal amount paid down during the preceding 365 days:

$\text{Reduction} = \text{Highest Balance in Lookback Window} - \text{Current Balance} = \text{Principal Paid Down in Window}$

By subtracting this principal paydown from $50,000, the participant is prevented from re-borrowing the amounts they just repaid until a full 365 days have elapsed since the higher balance existed.

The Exact 1-Year Window: "Day Before the Date Made"

A frequent testing nuance on the ASPPA QKA exam is the exact statutory timeline for the lookback window. Under IRC §72(p)(2)(A)(i), the 1-year period ends on the day before the date on which the new loan is made:

• If a new loan is made on October 15, 2025, the 1-year lookback period runs from October 15, 2024 through October 14, 2025.
• Any loan balance existing on October 15, 2024 (exactly 365 days prior to the day before origination) is captured in the calculation.

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Multi-Step Mathematical Walkthroughs & Case Studies

To master ASPPA QKA exam calculations, administrators must work through multi-step scenarios involving various vested balances, prior loans, paydowns, and payoffs.

Case Study 1: First-Time Borrower with Substantial Account Balance

• Participant: Sarah
• Vested Account Balance: $160,000
• Prior Plan Loans: None (Highest balance in prior 365 days = $0; Current balance = $0)
• Plan Terms: Plan allows loans up to statutory limits; permits up to 2 active loans.

Calculation Steps:

1. Cap 1 (Adjusted $50,000 Cap): $\text{Cap 1} = \$50,000 - (\$0 - \$0) = \$50,000$
2. Cap 2 (Vested Balance Cap): $\text{Cap 2} = \max(50\% \times \$160,000, \$10,000) = \max(\$80,000, \$10,000) = \$80,000$
3. Lesser of Cap 1 or Cap 2: $\min(\$50,000, \$80,000) = \$50,000$
4. Maximum New Loan Capacity: $\$50,000 - \$0 = \mathbf{\$50,000}$ Sarah can borrow up to $50,000.

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Case Study 2: Small Vested Account Balance & The $10,000 De Minimis Rule

• Participant: David
• Vested Account Balance: $14,000
• Prior Plan Loans: None
• Plan Terms: Plan document expressly incorporates the statutory $10,000 de minimis safe harbor.

Calculation Steps:

1. Cap 1 (Adjusted $50,000 Cap): $\text{Cap 1} = \$50,000 - (\$0 - \$0) = \$50,000$
2. Cap 2 (Vested Balance Cap): $\text{Cap 2} = \max(50\% \times \$14,000, \$10,000) = \max(\$7,000, \$10,000) = \$10,000$
3. Lesser of Cap 1 or Cap 2: $\min(\$50,000, \$10,000) = \$10,000$
4. Maximum New Loan Capacity: $\$10,000 - \$0 = \mathbf{\$10,000}$ Under the tax code, David can borrow up to $10,000.

[!WARNING] Plan Document Election Criticality: If the written plan document does not adopt the $10,000 de minimis safe harbor, Cap 2 is strictly 50% of the vested balance ($7,000). A plan administrator who distributes $10,000 when the plan document specifies a 50% limit commits an operational failure, causing a $3,000 deemed distribution!

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Case Study 3: Partial Paydown with an Existing Active Loan

• Participant: Michael
• Vested Account Balance: $120,000
• Loan History:
  • On January 15, 2024, Michael borrowed $40,000 (Loan 1).
  • Over the past 12 months, Michael made regular bi-weekly payroll deduction payments.
  • On November 1, 2024, Michael's outstanding loan balance is $25,000.
  • During the 1-year lookback window (November 2, 2023 through November 1, 2024), Michael's highest outstanding balance was $40,000.
  • On November 2, 2024, Michael requests a second loan (Loan 2). The plan allows two active loans.

Step-by-Step Calculation:

1. Determine Lookback Reduction: $\text{Highest Balance in Prior 365 Days} = \$40,000$ $\text{Current Outstanding Balance} = \$25,000$ $\text{Lookback Reduction Amount} = \$40,000 - \$25,000 = \$15,000$
2. Calculate Cap 1 (Adjusted $50,000 Cap): $\text{Cap 1} = \$50,000 - \$15,000 = \$35,000$
3. Calculate Cap 2 (Vested Balance Cap): $\text{Cap 2} = \max(50\% \times \$120,000, \$10,000) = \max(\$60,000, \$10,000) = \$60,000$
4. Determine Maximum Allowable Aggregate Loan Balance: $\min(\text{Cap 1}, \text{Cap 2}) = \min(\$35,000, \$60,000) = \$35,000$
5. Calculate Maximum New Loan Borrowing Capacity: $\text{New Loan Capacity} = \$35,000 - \text{Current Outstanding Balance} (\$25,000) = \mathbf{\$10,000}$ Michael is eligible to borrow a new loan of up to $10,000. If Michael borrows $10,000, his total outstanding plan debt will be $35,000 ($25,000 + $10,000), which satisfies the statutory ceiling.

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Case Study 4: Full Payoff Followed by Rapid Re-Borrowing (The Anti-Churning Freeze)

• Participant: Elena
• Vested Account Balance: $200,000
• Loan History:
  • Elena took a $50,000 loan two years ago.
  • On March 1, 2025, the outstanding balance was $30,000.
  • On April 15, 2025, Elena received an outside cash bonus and paid off the entire remaining $30,000 balance in a single lump sum. Her outstanding loan balance dropped to $0.
  • On July 1, 2025, Elena experiences an unexpected financial emergency and applies for a new plan loan.

Step-by-Step Calculation:

1. Identify the 1-Year Lookback Window:
   • Date of new loan: July 1, 2025.
   • Lookback window: July 1, 2024 through June 30, 2025.
   • Within that 365-day window, Elena's highest outstanding balance was on July 1, 2024, when her balance was $38,000.
   • Her current outstanding balance on July 1, 2025 is $0.
2. Calculate Lookback Reduction: $\text{Reduction} = \text{Highest Balance} (\$38,000) - \text{Current Balance} (\$0) = \$38,000$
3. Calculate Cap 1 (Adjusted $50,000 Cap): $\text{Cap 1} = \$50,000 - \$38,000 = \mathbf{\$12,000}$
4. Calculate Cap 2 (Vested Balance Cap): $\text{Cap 2} = 50\% \times \$200,000 = \$100,000$
5. Determine Maximum Allowable Aggregate Loan Balance: $\min(\$12,000, \$100,000) = \$12,000$
6. Calculate Maximum New Loan Borrowing Capacity: $\text{New Capacity} = \$12,000 - \$0 = \mathbf{\$12,000}$ Despite having a $200,000 vested account balance and zero outstanding debt on the date of application, Elena can borrow only $12,000! The lookback rule severely restricts her borrowing capacity because she paid off $38,000 of principal within the preceding 12 months. She will not regain access to the full $50,000 cap until April 16, 2026 (one year and one day after her final payoff).

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Plan Aggregation Rules: IRC §72(p)(2)(D)

Under IRC §72(p)(2)(D), when applying the statutory loan limits (both Cap 1 and Cap 2):

"All plans of the employer shall be treated as 1 plan."

Furthermore, the statute incorporates the broad controlled group and affiliated service group rules of IRC §414:

• Parent-Subsidiary Controlled Groups (IRC §414(b))
• Brother-Sister Controlled Groups (IRC §414(b) / §414(c))
• Unincorporated Trades or Businesses Under Common Control (IRC §414(c))
• Affiliated Service Groups (IRC §414(m))
• Other Aggregated Entities (IRC §414(o))

+-----------------------------------------------------------------------------------+
|              CONTROLLED GROUP PLAN AGGREGATION UNDER IRC §72(p)(2)(D)             |
+-----------------------------------------------------------------------------------+
|                                                                                   |
|        PARENT CORP (100% Owner)               SUBSIDIARY CORP (100% Owned)        |
|        Sponsors: Plan A (401(k))              Sponsors: Plan B (Profit-Sharing)   |
|        Participant: Marcus                    Participant: Marcus                 |
|        Vested Balance: $100,000               Vested Balance: $50,000             |
|        Active Loan: $20,000                   Active Loan: $0                     |
|                                                                                   |
|   Marcus requests a new loan from Plan B:                                         |
|   • Plan A and Plan B MUST be aggregated as a single plan!                        |
|   • Total Vested Balance = $100,000 + $50,000 = $150,000                          |
|   • Existing Loan Debt in Plan A ($20,000) reduces Cap 1 and borrowing capacity   |
|     in Plan B dollar-for-dollar!                                                  |
+-----------------------------------------------------------------------------------+

Operational Impact of Controlled Group Aggregation

1. Unified $50,000 Ceiling: A participant who works for two related employers within a controlled group does not receive two separate $50,000 loan allowances. The $50,000 limit is a single, aggregated ceiling across all plans of all related entities.
2. Lookback Aggregation: Highest loan balances in any plan of any controlled group member during the prior 365 days reduce Cap 1 for any new loan requested from any other plan in the group.
3. Cross-Plan Vested Balance Aggregation: For Cap 2, the participant's vested accrued benefits in all aggregated plans are combined. If Marcus has $100,000 vested in Plan A and $50,000 vested in Plan B, his 50% limit is based on $150,000 ($75,000 cap).
4. Unrelated Employer Exception: If a participant moves to an entirely unrelated employer that is not part of an IRC §414 controlled group, loans held in the prior employer's plan are not aggregated with the new employer's plan.

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Prohibited Transaction Exemption: ERISA §408(b)(1) & IRC §4975(d)(1)

Under ERISA §406(a)(1)(B) and IRC §4975(c)(1)(B), a lending of money or extension of credit between a qualified retirement plan and a "party in interest" (ERISA) or "disqualified person" (IRC) is a per se prohibited transaction. Because all plan participants who are employees of the sponsoring employer are parties in interest under ERISA §3(14)(H), every participant loan would be an illegal prohibited transaction without a specific statutory exemption.

Congress provided that statutory safe harbor in ERISA §408(b)(1) and IRC §4975(d)(1). To qualify for the prohibited transaction exemption, participant loans must satisfy five mandatory statutory criteria:

                    THE 5 PILLARS OF ERISA §408(b)(1) LOAN EXEMPTION
                                          │
      ┌─────────────────┬─────────────────┼─────────────────┬─────────────────┐
      ▼                 ▼                 ▼                 ▼                 ▼
[ REASONABLY      [ NON-DISCRIM-     [ SPECIFIC PLAN    [ REASONABLE      [ ADEQUATELY
  EQUIVALENT        INATORY TO         PROVISIONS         INTEREST          SECURED ]
  BASIS ]           HCES ]             MANDATE ]          RATE ]            Up to 50% of
Available to all  Loans not made     Governed by        Commensurate      vested account
parties in        available to       formal written     with commercial   balance pledged
interest on equal HCEs in greater    loan policy and    lending rates     as trust
terms.            percentages.       plan terms.        (Prime + 1-2%).   collateral.

1. Available on a Reasonably Equivalent Basis

Loans must be available to all participants and beneficiaries regardless of race, color, religion, sex, age, or national origin. Furthermore, loans cannot be restricted solely to active employees if former employees (e.g., retirees or terminated participants) or alternate payees remain parties in interest.

• Permissible Minimum Loan Threshold: Under Department of Labor regulations (29 CFR §2550.408b-1(b)(2)), a plan may establish a minimum loan amount of up to $1,000. The DOL has ruled that a $1,000 minimum does not violate the "reasonably equivalent basis" requirement because administrative costs make smaller loans economically impracticable.

2. Not Made Available to HCEs in Greater Amounts

Loans cannot discriminate in favor of Highly Compensated Employees (HCEs). A plan cannot offer loans of up to 50% of vested account balance to HCEs while limiting Non-Highly Compensated Employees (NHCEs) to 25%. However, because Cap 2 is percentage-based (50% of vested balance), the fact that an HCE with a $500,000 account can borrow $50,000 while an NHCE with a $20,000 account can borrow only $10,000 is not discriminatory—the percentage availability is identical.

3. Made in Accordance with Specific Plan Provisions

The plan document or a separate written Participant Loan Program / Loan Policy adopted by the plan administrator must explicitly detail:

• The identity of the loan administrator;
• The application procedure;
• The basis on which loans will be approved or denied;
• The limitations (if any) on types and amounts of loans;
• The procedure for determining a reasonable rate of interest;
• The types of collateral acceptable as security;
• The events constituting default and the steps taken on default.

4. Bear a Reasonable Rate of Interest

The loan must provide the plan with a return commensurate with interest rates charged by third-party commercial lenders for loans made under similar circumstances (examined thoroughly in Section 9.2).

5. Adequately Secured

The plan trust must obtain sufficient collateral to ensure that no loss of plan assets occurs in the event of default.

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The Critical Conflict: DOL 50% Adequate Security vs. IRS $10,000 Safe Harbor

One of the most complex, heavily tested compliance issues on the ASPPA QKA examination is the regulatory friction between tax law (IRC §72(p)) and labor law (ERISA §408(b)(1)) regarding small account balances.

The Labor Law Rule: 29 CFR §2550.408b-1(f)(2)

Under Department of Labor Regulation §2550.408b-1(f)(2), for a loan to be "adequately secured" by a participant's vested accrued benefit, no more than 50% of the present value of the participant's vested account balance may be considered by the plan as security for the outstanding balance of all loans made to the participant.

$\text{Maximum Vested Account Balance Pledged as Collateral} = 50\% \times \text{Vested Accrued Benefit}$

The Statutory Clash

Consider a participant with an $8,000 vested account balance:

• Under IRC §72(p)(2)(A): The tax code allows a loan up to the greater of 50% of vested balance ($4,000) or $10,000 (capped at the total account balance). Therefore, from an IRS tax standpoint, the participant can borrow the full $8,000 without triggering a deemed distribution!
• Under DOL Reg. §2550.408b-1(f)(2): The plan can pledge only 50% of the account ($4,000) as security. If the plan lends $8,000 secured solely by the participant's account balance, $4,000 of the loan is completely unsecured!

+-----------------------------------------------------------------------------------+
|             THE $10,000 DE MINIMIS COLLATERAL TRAP: IRS VS. DOL RULES             |
+-----------------------------------------------------------------------------------+
|  Participant Vested Balance: $8,000                                               |
|                                                                                   |
|  [ IRS TAX CODE: IRC §72(p) ]             [ DOL LABOR LAW: ERISA §408(b)(1) ]     |
|  • De minimis safe harbor allows $8,000   • Mandatory Adequate Security Rule      |
|  • NO Deemed Distribution under §72(p)    • Max 50% of account pledged ($4,000)   |
|                                           • Remaining $4,000 is UNSECURED!        |
|                                           • UNSECURED LOAN = PROHIBITED           |
|                                             TRANSACTION under ERISA §406 / §4975! |
+-----------------------------------------------------------------------------------+
                                     │
                                     ▼
      PRACTICAL RESULT: Plan cannot lend more than $4,000 (50% of balance)
      unless the participant pledges outside collateral (e.g. CD or home equity)!

Practical Operational Resolution

Because almost no 401(k) plan sponsor or TPA wants the administrative burden of perfecting liens on outside personal property (such as second mortgages or bank certificates of deposit), standard pre-approved plan documents and loan policies routinely omit the $10,000 de minimis safe harbor or explicitly restrict loans to the lesser of $50,000 or 50% of the vested balance. If an administrator issues a $10,000 loan to a participant with a $12,000 vested balance without outside collateral, the plan sponsor has committed a prohibited transaction under IRC §4975, triggering a mandatory 15% annual excise tax on Form 5330!

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Common ASPPA QKA Exam Traps

• Exam Trap 1: Double-Subtracting Current Loan Balances: When calculating new loan capacity, candidates often subtract the current balance to find Cap 1, and then mistakenly subtract it again at the end. Remember the two distinct steps: (1) calculate the reduction amount using highest balance minus current balance; (2) once the overall cap is determined, subtract the current balance from that cap to find the incremental new loan amount.
• Exam Trap 2: The Lookback Full-Payoff Illusion: An exam question describes a participant who had a $50,000 loan, paid it off in full yesterday, and asks how much they can borrow today. Candidates intuitively answer $50,000 because the participant owes $0. The correct answer is $0! The lookback reduction is $50,000 - $0 = $50,000, reducing Cap 1 to $50,000 - $50,000 = $0.
• Exam Trap 3: Aggregating Unrelated Employers: If an employee leaves Employer A and joins Employer B (unrelated entities under IRC §414), an outstanding loan from Employer A's plan does not reduce borrowing capacity under Employer B's plan.
• Exam Trap 4: IRA Loan Confusion: Exam scenarios frequently ask if an individual can take a 5-year loan from their Traditional or Roth IRA to purchase a car or pay tuition. IRAs never permit loans. Any borrowing from an IRA triggers full account disqualification and taxation of the entire account under IRC §408(e)(2).
• Exam Trap 5: Lookback Window Date Boundaries: The 1-year lookback period ends on the day before the new loan is made. If a loan is made on June 1, 2025, the lookback window is June 1, 2024 through May 31, 2025.