Even though it’s a minor percentage of the total cost of buying a home, rising prices have made affording a down payment increasingly difficult for aspiring buyers to save up for. One way to bridge the gap between your savings and what you need to buy a home is to use retirement savings.
Here’s how you can use retirement savings for a down payment on a house, as well as the pros and cons of doing so.
Can I Use My Retirement Funds for a Down Payment?
Yes, it is possible to use retirement funds for a down payment on a home. The trade-off is that while it may help you buy a home sooner instead of continuing to save for a down payment, you also deplete your retirement investment.
“In some cases, homebuyers may be able to use their retirement funds, such as a 401(k) or IRA, to cover a down payment,” says Nathan Claire, a Realtor and founder of Buying Jax Homes in Jacksonville, Florida. “However, this can have significant financial implications, including early withdrawal penalties and taxes. Homebuyers should consult with a financial advisor before using retirement funds for a down payment.”
What Types of Retirement Funds Can I Use?
Here’s how you can use the funds from a retirement account for a down payment on a house. It’s a good idea to consult a financial advisor or tax expert before withdrawing funds from your retirement accounts.
Individual retirement account
If you want to use funds from a traditional, SIMPLE, or Roth individual retirement account to make a down payment, you can withdraw up to $10,000 without penalty. If you’re younger than 59 1/2 years old, you typically have to pay a 10% tax penalty for an early withdrawal. However, the IRS makes an exception when this money is withdrawn to buy, build, or rebuild a home.
If you’re looking to use funds from a 401(k), then either you can make a standard withdrawal and pay taxes and any penalties, or you can borrow up to 50% of your vested account balance, up to $50,000.
With the latter option, you’re essentially taking out a loan against your account balance. You’ll need to repay it within five years, but repaying it won’t count against your debt-to-income ratio. If you leave your job before the loan is repaid, the remaining balance must be paid immediately, or it will be treated as a distribution.
How Can I Access My Retirement Funds for a Down Payment?
There are a couple of different ways to access your retirement funds. The right selection for you will depend on your situation and your priorities.
When you take out a 401(k) loan, you’re borrowing against your own asset. A 401(k) loan may be preferable to a 401(k) withdrawal for several reasons:
- You can avoid paying a 10% early withdrawal penalty.
- The money won’t be taxed as income.
- The loan won’t count toward your debt-to-income ratio.
- The loan won’t hurt your credit.
However, there are some drawbacks to this option:
- The maximum amount you can withdraw is $50,000.
- You have to pay the loan back with interest, which usually is 1% to 2% above the prime interest rate, with after-tax dollars.
- Your reduced retirement savings can’t make as much money as a larger amount.
- If you fail to repay the loan, you face taxes and penalties.
- Not all employers offer a 401(k) loan option.
Instead of taking out a loan against your 401(k), you can make a straight withdrawal. However, if you’re younger than 59 1/2, you will pay a 10% penalty on that money unless the withdrawal is needed to meet “an immediate and heavy financial need.”
Whether a home purchase qualifies is up to your employer. In most cases, you’ll have to pay the early withdrawal penalty, so you’d need to take out 10% more than you need and then kiss it goodbye.
Pros and Cons of Using Retirement Funds for a Down Payment
Here are some of the benefits of using retirement funds for a down payment:
- You get to own a home sooner.
- It’s possible to access money to make a down payment without paying interest.
- It’s your money.
Some of the drawbacks of using your retirement funds for a down payment include:
- You deplete your savings.
- Your savings won’t grow as quickly.
- 10% early withdrawal penalty on a 401(k) if you’re under 59 1/2 years old.
- You’ll need to pay interest on the money you borrow from your 401(k).
Here are answers to some frequently asked questions about using retirement funds for a down payment.