IRA Withdrawals for First-Time Homebuyers: A Good Idea?

Down payments can be a barrier to homeownership, along with credit history and unaffordable home prices. Part of the problem is a lack of awareness: homebuyers might not be privy to all of the down payment options available to them.

One potential source of down payment funds is a penalty-free withdrawal from a traditional or Roth IRA. If you haven’t owned a home in the last two years, you can withdraw up to $10,000 from these retirement accounts to pay for your primary residence.

Can you use your IRA to buy a house?

Yes, you can use your IRA to buy a house.

An IRA is an individual retirement account, and there are two types: traditional and Roth. With either type, the IRS will allow you to take distributions of up to $10,000 over your lifetime, without paying an early withdrawal penalty, if you use the money to buy (or build) your primary residence.

Withdrawing from your IRA without penalty

Normally, you must pay a 10% penalty on any IRA distributions you take before age 59½. But as long as you are a first-time homebuyer (i.e., you haven’t owned a home in the last two years) and put the money toward “qualified acquisition costs,” you’ll be exempt from the penalty.

Qualified acquisition costs include standard financing costs as well as settlement costs, closing costs, and your down payment.

Find Out: How Much Does It Cost to Buy a Home?

How to use your IRA for a down payment

The rules for traditional and Roth IRAs differ somewhat when it comes to withdrawing money for a down payment on a home.

Withdrawing from a traditional IRA

When you withdraw money from a traditional IRA, you pay income tax on it. Income tax applies whether you’re withdrawing contributions or earnings unless you have made after-tax contributions to your traditional IRA.

Normally, if you withdraw money from a traditional IRA before age 59½, you’ll have to pay income tax plus a 10% penalty. However, when you’re withdrawing up to $10,000 to buy a home and you haven’t owned a home in the last two years, you won’t owe the 10% penalty.

Once you withdraw the money, you have 120 days to use it for your down payment (or any other qualified acquisition costs).

If you end up not using a portion of the withdrawal, you can return the unused funds to your IRA before the 120 days are up to avoid taxes and penalties.

Withdrawing from a Roth IRA

Since Roth IRA contributions are not tax deductible — in other words, you contribute to your Roth account with after-tax dollars — you won’t owe income tax should you decide to withdraw any contributions. If you withdraw earnings before age 59½, you normally must pay a 10% early withdrawal penalty.

However, you can withdraw up to $10,000 in Roth IRA earnings, penalty-free, to put toward a home purchase if you’ve had a Roth account for at least five years.

Like with a traditional IRA, once you withdraw the money, you have 120 days to use it for qualified acquisition costs, and you can return any unused portion before that time period is up to avoid taxes and penalties.

Should you tap your IRA for a home purchase?

Everyone’s situation is different. While many financial professionals advise against using IRA funds for a home purchase, others think it can be a smart move if you plan far enough ahead.

Here are the benefits and drawbacks to consider before you use your IRA for a home purchase:

Pros

• The money allows you to come up with the minimum down payment.
• If you and your spouse are both first-time homebuyers, you can each take advantage of the $10,000 withdrawal.
• Setting aside money in a Roth IRA for a future home purchase can potentially earn you better returns than if you were to store that money in a taxable savings account.^[1]

Cons

• Time is one of your biggest assets for earning compound returns from retirement investing. The opportunity cost of taking $10,000 from an IRA now could be more than $100,000 in retirement savings later. Homes in most areas don’t appreciate nearly as much as stocks.
• There’s a good chance that $10,000 will not make a big enough dent in your down payment to prevent you from needing private mortgage insurance.
• A $10,000 withdrawal from a traditional IRA may only amount to $8,800 or less after taxes, depending on your federal and state brackets.

Shopping around for a mortgage can be stressful. Fortunately, Credible streamlines this process and makes comparing multiple lenders easy.

Alternatives to withdrawing from your IRA

If you don’t want to withdraw from your IRA to buy a home, you have other options for funding a down payment.

Borrow from your 401(k)

Best for: Homebuyers who don’t want to take a permanent hit to their retirement savings

Unlike IRAs, 401(k) plans allow for loans. You can borrow up to 50% of your vested account balance or $50,000, whichever is less; if your balance is $10,000 or less, you can borrow up to $10,000.

One of the benefits of a 401(k) loan versus a distribution is you don’t have to pay taxes or penalties on the loan, and any interest you pay goes back into your retirement account.

If you don’t repay the loan, it will be treated as a taxable distribution and subject to the 10% early withdrawal penalty.

Borrow from your IRA

Best for: Homebuyers who have nearly enough for a down payment or avoiding PMI

While IRAs do not allow for loans, they do allow for rollovers. The rollover rules allow IRA funds to be outside an IRA account for 60 days. The idea behind this strategy is to withdraw money from your IRA, use it for your house, and then repay it within 60 days. You’re not actually doing a rollover; you’re just taking advantage of rollover rules.

This can potentially save you from having to pay PMI or allow you to buy a home sooner. However, unless you’re confident you’ll have enough income to repay the “rollover” within 60 days, you might end up owing an early withdrawal penalty, which could outweigh the benefits of this strategy.

Take a hardship distribution from your 401(k)

Best for: Homebuyers whose employers don’t offer 401(k) loans

Withdrawing money from a 401(k) to buy a home means sacrificing potential investment earnings on the principal you withdraw. You can potentially withdraw much more than $10,000, too, because hardship withdrawals are based on your financial need.

Yes, the IRS considers buying a home to be a “hardship.” Hardship withdrawals are subject to income tax and the 10% early withdrawal penalty. You’ll have to wait six months after the withdrawal before you can start contributing to your 401(k) again.

Get a government-secured mortgage

Best for: Qualified military service members and/or homebuyers with credit scores below 620

A VA loan allows qualified military service members to put nothing down to buy a home, while an FHA loan allows anyone to put as little as 3.5% down. USDA loans also require no down payment for low-income homebuyers outside big cities.

These mortgage loans have more lenient underwriting guidelines for borrowers because the government provides a loan guarantee to the lender.

Check Out: 5 Types of Mortgage Loans: Which One Is for You?

Get a low-down-payment conventional mortgage

Best for: Homebuyers with good credit

With a credit score of at least 620, you may qualify for a conventional mortgage with as little as 3% down. You’ll need to pay for PMI until you have 20% equity, but you’ll be able to own a home sooner. The higher your credit score, the lower your interest rate and the less expensive your PMI will be.

Look into mortgage assistance programs

Best for: Homebuyers who may not be able to come up with the minimum down payment

Instead of dipping into your IRA for a down payment, look into a mortgage assistance program. Programs are available in every state to help first-time and/or low-income homebuyers get a mortgage.

Learn more: Everything You Need to Know About Mortgage Credit Certificates (MCC)

^{[[1] Credible is not an investment advisor, and there’s no guarantee the market will perform well in the years leading up to your home purchase. Speak with an investment specialist beforehand to make sure this strategy is right for you.]}