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Buying a home can be a struggle for Americans, as it requires making a down payment. While you might be able to get away with putting less than 20% down, that likely means shelling out for private mortgage insurance (PMI) every month. And even if you can qualify for an FHA loan with a 3.5% down payment, that still means coming up with $7,000 in cash on a $200,000 home.
Many Americans simply don’t have the cash to cover their down payment. But if you meet certain requirements, 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 additional income tax or penalties. With few other options, more and more Americans are turning to this option.
The question is whether it’s a good idea to go this route. To find out, we’ll cover the pros and cons of pulling money out of your Roth IRA to buy a home.
Pros and cons of pulling money from a Roth IRA for homebuying
There are several pros and cons of using money from a Roth IRA to buy a home:
- First-time homebuyer exemption: The first-time homebuyer exemption allows you to withdraw up to $10,000 from a Roth IRA to pay for a home purchase. If you are a first-time homebuyer, you may be able to avoid penalties and fees from the withdrawal.
- Withdraw contributions at any time: Because contributions to a Roth IRA are made with after-tax dollars, you can withdraw the contributions (not earnings) at any time without incurring penalties or fees.
- Build home equity: If withdrawing from your Roth IRA enables you to buy a home, it can also allow you to start building home equity. This can also create wealth if the value of the property increases.
- Penalties and taxes: There are several scenarios in which you might pay penalties and taxes when withdrawing from your Roth IRA. For example, if you withdraw more than $10,000 as a first-time homebuyer, there may be penalties and taxes. Or if you withdraw earnings under 59 ½ and the account is under five years old, there may be a 10% penalty, plus taxes.
- Loss of potential earnings: Less money in your Roth IRA inevitably means a loss of compound interest. This means you will be lowering 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 cash available when you retire.
- Less liquidity: While homes are valuable assets that can appreciate, they are far less liquid than the money in your Roth IRA.
- Market risk: Homes can appreciate, but that is highly dependent on the local real estate market.
Alternatives to pulling money from a Roth IRA
There are several alternatives to using money from your Roth IRA to buy a home. Perhaps the simplest choice is to delay the purchase and set some cash aside until you have enough for a down payment. For example, you could open a high-yield savings account and add money to it until you have your down payment.
You might also consider a 401(k) loan. Unlike early Roth withdrawals, 401(k) loans can be repaid and you don’t reduce your 401(k) balance. However, you must pay interest as with other loan types.
If you already own a home, you can consider a home equity line of credit (HELOC). With this type of loan, you borrow against your existing home equity to fund your purchase. However, note that you put your home up as collateral with this kind of loan.
Using money from your Roth IRA to buy a home is tempting, especially with home prices constantly rising. And it has its advantages, such as penalty-free withdrawals of up to $10,000 for first-time homebuyers. But there are many potential downsides, like penalties and taxes and loss of potential earnings. In some cases, it may be better to wait until you can afford the down payment or consider a financing option such as a 401(k) loan or a HELOC.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.