Can I use my retirement to buy a house?

Using a 401(k) or IRA for a down payment can be costly.

When it comes to saving for retirement with a 401(k) or IRA, first-time home buyers have a tough call to make. You want to follow your dream, start a family and finally have your own home—but also retire comfortably and on time. So, do you withdraw from your IRA for that house with the perfect backyard? Or tap your 401(k) for a down payment and just wing it when you’re 65?

Actually, it’s possible to buy a home for yourself and save for your future retirement. How? Clamp down on your spending and ramp up your saving so you can retire somewhere sunny and have a place to call your own.

What if you use your 401(k) for a down payment?

While using your 401(k) funds to buy a house is an option, you may want to consider the long-term effects. On the positive side, you are borrowing money from yourself instead of a lender. But until you repay the loan, your 401(k) earnings take a dive because your retirement fund is investing with less money. That’s less money tomorrow for some quick cash today.

Also, you can only borrow up to 50% of your vested account balance with a $50,000 limit. You’ll have to make 4 large payments each year—plus interest—over the life of the loan. Oh, and that’s on top of your mortgage.

This takes a bite out of your paycheck and opens you up to the 10% early withdrawal penalty if you’re late paying back the loan. Plus, you’ll owe income tax on the full amount you borrow.1

Why withdrawing from your IRA for a house can work

With an IRA, first-time home buyers can borrow up to $10,000 for a down payment without incurring a tax penalty. But if this isn’t your first home and if you’re under 59½ years of age, then you’re going to get hit with a 10% income tax on the entire amount you withdraw from a traditional IRA.

Withdrawing from a Simple IRA instead? You should know up front that you’ll pay 25% in taxes. That’s money better off earning interest in your retirement savings account. But there is good news—if you have a Roth IRA, you won’t pay any taxes or penalties on anything you withdraw. This is one scenario where using your retirement money to buy a house might be a decent option.2

Consider alternatives to using your retirement to buy a house

Whether it’s your first home or your sixth, the last thing you want to do is put yourself at a disadvantage later on in life. So be kind to “future you” and put the work in. Get to know your finances, the home-buying process and the percentages that matter:

  1. Find your comfort zone. It’s tempting to go over the top with an everything-on-the-wish-list house. Just be careful you don’t end up “house poor” where you can’t afford furniture. It’s a good idea to budget for how much house you can realistically afford. Keep in mind that housing costs include your monthly mortgage principal, interest, taxes and insurance (aka PITI). A monthly bill that’s too high can pinch your budget in other areas like travel or retirement savings.
  2. Adjust your down payment. A 20% down payment is ideal for a number of reasons, including being more likely to qualify for a loan and getting a better interest rate. But most importantly, 20% down means you won’t need private mortgage insurance (PMI), which can add hundreds of dollars to your monthly payments.3 That’s thousands of dollars that would do better accruing interest in your retirement savings plan so you can use it for something else you want later.
  3. Try the 50/20/30 budget. Consider following the 50/20/30 rule. This is a simple way to help keep your savings goals on track while still leaving enough money to go out for dinner or take a spontaneous trip. It breaks down like this: 50% of your income goes to necessities like food, housing, clothes, transportation, etc., and 20% goes right into your savings and investments. And the remaining 30%? Call this personal expenses—use it to buy furniture, treat yourself or think ahead and invest what you don’t spend. Check the Consumer Financial Protection Bureau’s worksheet to get started.

Your first home is a big step, so using your retirement to buy a house isn’t a light decision. Weigh the pros and cons before withdrawing from your 401(k) or IRA for a down payment. There may be other options (like a strong budget) that hold the key to saving for retirement while purchasing your dream home. You can also check out government home-buying programs meant to help bring costs down, so you can still stay on track for your retirement goals while you start to turn your new house into a home.

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