Buying a home can be a struggle for Americans, as it requires making a down payment. While you can get away with less than 20% down, that probably means shelling out for private mortgage insurance (PMI) every month. And even though you may qualify for an FHA loan with a 3.5% down payment, that still means you have $7,000 in cash for a $200,000 home.
Many Americans simply don’t have the cash to cover their down payment. But if you meet certain conditions, you can potentially withdraw up to $10,000 from your Roth IRA without taxes or penalties. You can also withdraw any of your Roth IRA contributions at any time without paying income tax or additional penalties. With few other options, more and more Americans are turning to this option.
The question is whether it is a good idea to go this route. To find out, we’ll cover the pros and cons of taking money out of your Roth IRA to buy a home.
Advantages and disadvantages of withdrawing money from a Roth IRA for the purchase of a house
There are several pros and cons to using money from a Roth IRA to buy a home:
- Exemption for home ownership: The first-time homebuyer exemption allows you to withdraw up to $10,000 from a Roth IRA to pay for the purchase of a home. If you’re a first-time home buyer, you may be able to avoid penalties and withdrawal fees.
- Withdraw contributions at any time: Because contributions to a Roth IRA are made with after-tax dollars, you can withdraw contributions (not earnings) at any time without incurring penalties or fees.
- Building home equity: While withdrawing from your Roth IRA allows you to buy a home, it can also allow you to start building equity in your home. It can also create wealth if the value of the asset increases.
- Penalties and taxes: There are several scenarios in which you could pay penalties and taxes when withdrawing from your Roth IRA. For example, if you withdraw more than $10,000 as a first-time home buyer, there may be penalties and taxes. Or if you withdraw income under age 59.5 and the account is less than five years old, there may be a penalty of 10% plus tax.
- Loss of potential earnings: Less money in your Roth IRA inevitably means a loss of compound interest. That means you’re reducing the earning potential of your Roth IRA and hurting your retirement.
- Reduced retirement savings: The purpose of the IRA is to fund your retirement. Withdrawing funds early means you may have less money available when you retire.
- Less liquidity: Although homes are valuable assets that can appreciate, they are much less liquid than the money in your Roth IRA.
- Market risk: Houses can appreciate, but it depends heavily on the local real estate market.
Alternatives to withdrawing money from a Roth IRA
There are several alternatives to using money from your Roth IRA to buy a home. Perhaps the easiest choice is to delay the purchase and put some money aside until you have enough money for a down payment. For example, you can open a high-yield savings account and add money to it until you have your down payment.
You can also consider a 401(k) loan. Unlike Roth’s early withdrawals, 401(k) loans can be repaid and you don’t reduce your 401(k) balance. However, you have to pay interest like other types of loans.
If you already own a home, you may want to consider a home equity line of credit (HELOC). With this type of loan, you borrow against the equity in your existing home to finance your purchase. However, note that you are putting your house as collateral with this type of loan.
Using money from your Roth IRA to buy a home is tempting, especially with ever-rising home prices. And it has its perks, like penalty-free withdrawals of up to $10,000 for first-time home buyers. But there are plenty of potential downsides, like penalties and taxes and potential loss of revenue. In some cases, it may be best to wait until you can pay the down payment or consider a financing option such as a 401(k) loan or HELOC.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. Further, investors are cautioned that past performance of investment products does not guarantee future price appreciation.