Buying a Home With Retirement Savings: Pros and Cons

If you’ve steadily deposited money into a retirement account for several years, you might be wondering if you can tap into those savings when it comes time to buy a new home. The short answer is yes – you can withdraw funds from a retirement account to help fund the down payment or pay closing costs, but there are pros and cons to taking out the money sooner than account guidelines permit.

The Pros

First, a house is one of the best investments you can make today. Granted, so are retirement savings accounts, but what makes a home unique is the opportunity for long-term gain. Generally speaking, homes appreciate over time, meaning the real estate or land will likely be worth more as the years go by. And during that time, you’ll build equity by paying down your mortgage balance.

Let’s say your home appraises for $200,000, but you still owe $60,000 on your loan. If you subtract $60,000 from $200,000, you get your home equity: $140,000. Sounds great, right? But what does that number mean? Building equity is one of the major bonuses of being a homeowner. By building equity, your home becomes a valuable asset that you can use down the road. Let’s take that $140,000 worth of equity in the example above. This is the amount of money that you’d have if you sold that home right now. You could use that money to buy a new home, car, pay for college tuition, or make any other large purchase. Another positive to withdrawing retirement funds early is avoiding the need to pay private mortgage insurance (PMI)An insurance policy that protects the lender in case you default on your loan. Mortgage insurance is required for FHA loans and for Conventional loans when you put down less than 20%.private mortgage insurance (PMI)An insurance policy that protects the lender in case you default on your loan. Mortgage insurance is required for FHA loans and for Conventional loans when you put down less than 20%.. The most common PMI is borrower-paid mortgage insurance, where you, the borrower, pay for the insurance. You’ll either pay PMI as a monthly premium added to your mortgage payment, once as an upfront cost at closing, or as a mixture of one upfront payment followed by monthly payments. For clarification on PMI, you can reach out to us directly, but using retirement funds to make your down payment could help you avoid that pesky PMI altogether. Bottom line, using those retirement funds to purchase a home can be a great option. But always speak to your financial professional to determine how to best manage those investments.

The Cons

Conversely, withdrawing from a retirement account hurts your earning potential. A major appeal of retirement accounts is compounding interest, or the interest you earn on the initial principal interest that has accumulated over time. In other words, the interest you earn on interest. So, the more you have in your account, the more you make with compounding interest each year. Taking out any funds now reduces the amount interest can build upon. And after the down payment and closing costs comes your monthly mortgage payments. Ensure you can take those on, along with any future deposits to catch up on your retirement savings, before making a withdrawal. You can reach out to us directly for an estimate of how much you’ll pay in mortgage each month. But most importantly, there are a few differences between the popular retirement account types when it comes to withdrawals:

Withdrawing From a 401(K)

In most cases, withdrawing from a 401(K) account that’s less than five years old or before you’ve reached the age of 59 and a half will incur a 10% penalty. The IRS activates that tax penalty on some, but not necessarily all, of the withdrawal amount. One way to avoid the penalty is to take out a loan on your retirement account. Again, always consult your financial and tax professionals for guidance. Depending on your employer’s plan, you can take out as much as 50% of your savings as a loan. You must pay the funds back, with interest, typically within five years. Contact your 401(K) administrator to learn more about the loan and eligibility.

Withdrawing From a Traditional IRA

Unlike the 401(K), you can withdraw up to $10,000 from a traditional individual retirement account (IRA) to put towards the purchase of – keyword – your FIRST home without penalty. The IRS defines a “first-time homebuyer” as someone who hasn’t, along with their spouse, owned a principal residence in the last two years. You’ll have to pay income tax on the amount withdrawn, and you must use the funds within 120 days of their distribution.

Withdrawing From a Roth IRA

Roth IRAs differ from traditional IRAs because the balance has already been taxed. But for withdrawals, you can also take out up to $10,000 for a “first-time” home purchase without penalty. The only portion eligible for taxation is any amount earned from an investment.

Getting Over the Down Payment Hurdle

Withdrawing from your retirement isn’t your only option if you need the extra cash to make your down payment. There are low down payment programs that make the barrier to homeownership a little less daunting for both first-time and experienced buyers. For example, some Conventional loan programs need as little as 3-5% down. FHA loans require only a 3.5% down payment, and USDA financing is available with no down payment at all. Reach out today to learn more about your financing options.