Younger homeowners more likely to have used retirement savings for a down payment — should you?

Home prices are near record highs and mortgage rates are above 7 percent. Meanwhile, unemployment remains below 4 percent, and many Americans have begun saving for retirement before they’ve become homeowners. The stock market has been booming, too, fattening up savers’ retirement balances.

Combine those trends, and fully 9 percent of American homeowners say they tapped their retirement savings to buy their house, according to Bankrate’s Down Payment Survey. Not surprisingly, younger homeowners were more likely to have used retirement savings for a down payment: 16 percent of Generation Z (ages 18-27) and 12 percent of millennials (ages 28-44) had done so, compared to just 7 percent of Generation X (ages 45-59) and 8 percent of baby boomers (ages 60-78).

In a separate Bankrate survey, Americans said their top financial regret was not beginning to save for retirement earlier. In other words: Tapping your savings now might bother you later.

Can you use retirement savings for a home down payment?

You can use your retirement savings for a home down payment. However, raiding your 401(k) or individual retirement account (IRA) comes with significant downsides.

To boil it down: Taking a straight withdrawal from your retirement savings is almost always a bad idea — but, you can borrow from your 401(k), which is much less costly than a withdrawal. You can’t take a loan from an IRA.

Is it OK to take money out of a 401(k) to buy a home?

When deciding whether to tap retirement savings for buying a home, a variety of factors come into play.

You could simply take money out of your retirement savings, but this is often a risky move for two reasons:

1. Early withdrawals from a 401(k) or traditional IRA can result in penalties and taxes — a bite that could reduce your homebuying budget, among other financial consequences.
2. You’ll miss out on potential investment gains from the money you withdraw, which could shrink your retirement nest egg over the long term.

Mark Hamrick, Bankrate’s senior economic analyst, calls early withdrawals from retirement savings “the personal financial equivalent of robbing Peter to pay Paul.”

“If a homebuyer is so strapped for funds that they feel the best option is to tap their retirement saving, I’d suggest delaying the purchase or looking into other means of financing,” says Hamrick.

The IRS encourages workers to save for retirement by sheltering income directed to 401(k) plans and IRAs from taxes.

If you withdraw funds from your 401(k) before you reach the age of 59 ½, you might face a 10 percent early withdrawal penalty, in addition to income tax on the amount withdrawn.

One workaround is taking your contributions from a Roth plan, if you have one — you’ve already paid taxes on that income, but earnings on the account remain taxable.

If you have an IRA, you have a bit of flexibility. The IRS allows you to withdraw up to $10,000 without penalties for a first-time home purchase, meaning you haven’t owned a home in the past two years. However, you’ll still have to pay income tax on the amount withdrawn if you’re pulling from a traditional IRA.

If you have a 401(k), there is a more palatable way to tap savings than a straight-up withdrawal: You can borrow up to $50,000 from your account. You’ll have to repay what you borrow, plus interest, within five years, but you’ll avoid those costly taxes and penalties. The money goes back into the account on an after-tax basis.

In addition to these financial considerations, it’s also important to think about the emotional and psychological implications of tapping your retirement savings. For many people, retirement savings are untouchable — a safety net for the future that shouldn’t be depleted except in dire circumstances. Raiding these funds to buy a home can create feelings of insecurity and anxiety about the future.

What other sources of cash can I use for a down payment?

If you’re looking to buy a home but don’t have enough cash for a down payment, there are several other sources you could consider before your retirement savings:

• Put off the purchase to save more. It might make sense to delay homeownership and save up a larger down payment. This strategy can give you time to build up your savings without dipping into your retirement funds.
• Obtain a gift or loan from family. If you have family members who are willing and able to help, they could provide a gift or loan to assist with your down payment.
• Apply for a low-down payment mortgage program. You don’t have to put down 20 percent to buy a home. If you qualify, a conventional loan can be had for 3 percent down, while an FHA loan only requires 3.5 percent. Here’s how to determine which loan type would work better for you.
• Look into down payment assistance programs. Most states and some counties and cities offer down payment assistance programs for first-time homebuyers or buyers with low to moderate incomes. These programs often provide grants or loans to cover some or all of your down payment.

How to decide what’s right for you

If you take a 401(k) loan or a Roth IRA loan to fund buying a home — or if you withdraw the money altogether — you’re making a tradeoff. While the money is out of the market and in your home, it isn’t generating a return in your investment portfolio. That might mean you have less money in retirement.

On the other hand, it’s possible you get lucky and pull the money out just before stocks fall — but don’t count on that sort of fortunate market timing.

You might also think about your projected returns. Stocks grow by 8 percent to 9 percent a year on average, while home values generally appreciate by less than that.

However, the calculations quickly get tricky. For instance, using a mortgage to buy a home amplifies your returns. If your $400,000 home appreciates to $500,000 over four years, that represents a 25 percent total gain, or a bit more than 5 percent a year. If your actual investment was a $100,000 down payment, then that $100,000 gain is amplified to 100 percent, or more than 20 percent a year. (This is a very simplified example.)

While the conventional wisdom says you should leave your retirement funds untouched, homeownership might be difficult to achieve without dipping into your retirement accounts. If you feel strongly about homeownership or you think of rent payments as wasted money, it might make sense to forgo some future retirement savings to buy a home now.

On the flip side, if your budget is such that you’re considering a loan from your retirement plan, it might be time for a reality check.

“The total cost of ownership beyond mortgage payments, insurance and property taxes also includes maintenance, repair and eventually renovation,” says Hamrick. “For some, stretching to come up with a down payment by resorting to a last-ditch solution could well set them up for financial struggles down the road.”

If you’re considering using retirement funds for a home purchase, consult with a financial advisor. A professional can help you understand all the implications of this decision and explore other potential options.

• Methodology

  All figures, unless otherwise stated, are from YouGov Plc. Total sample size was 2,267 adults, of whom 1,208 currently own a home. Fieldwork was undertaken between Jan. 24-26, 2024. The survey was carried out online. The figures have been weighted and are representative of all US adults (aged 18+).