For Americans, purchasing a home can be challenging because it involves making a down payment. If you put down less than 20%, you may have to pay for private mortgage insurance each month. Even with an FHA loan requiring a 3.5% down payment, you’d still need $7,000 in cash for a $200,000 home.
If you are struggling to come up with the down payment, you may be eligible to withdraw up to $10,000 from your Roth IRA without incurring taxes or penalties. Additionally, you can withdraw your contributions from your Roth IRA anytime without paying extra taxes or penalties. This option is becoming increasingly popular among Americans who don’t have many other choices.
The issue at hand is whether it is wise to use funds from your Roth IRA in order to purchase a home. We will explore the advantages and disadvantages of this decision.
Pros and cons of pulling money from a Roth IRA for homebuying
Using funds from a Roth IRA to purchase a home comes with advantages and disadvantages.
Pros
- First-time homebuyer exemption: If you’ve never owned a home before, you can take advantage of the first-time homebuyer exemption, which permits you to withdraw up to $10,000 from your Roth IRA to use for buying a home. By using this exemption, you may avoid any penalties and charges associated with the withdrawal.
- Withdraw contributions at any time: You can withdraw the contributions made to a Roth IRA, which are after-tax, at any time without facing penalties or fees. This rule applies only to the contributions and not to any earnings.
- Build home equity: If you use funds from your Roth IRA to purchase a home, you can begin to accumulate equity in the property and potentially benefit from any increase in its value, which could lead to building wealth.
Cons
- Penalties and taxes: Withdrawing funds from your Roth IRA may result in penalties and taxes in certain situations. For example, withdrawing over $10,000 if you’re a first-time homebuyer can lead to penalties and taxes. Furthermore, there might be a 10% penalty and taxes if you withdraw earnings when you’re under 59 ½ and the account is under five years old.
- Loss of potential earnings: If there is less money in your Roth IRA account, you will miss out on the benefits of compound interest. This can lead to a decrease in your Roth IRA’s potential earnings, which can negatively impact your retirement funds.
- Reduced retirement savings: The IRA is designed to help you save money for your retirement. If you withdraw money from it before retiring, you could have less money to use when you actually do retire.
- Less liquidity: Although homes can appreciate and hold significant value, they are less easily converted into cash than the funds in your Roth IRA.
- Market risk: Whether or not homes appreciate is closely tied to the condition of the local real estate market.
Alternatives to pulling money from a Roth IRA
Instead of using money from your Roth IRA to buy a home, you can consider other options. One easy alternative is to wait to buy the home and save up enough cash for a down payment. You can do this by starting a high-yield savings account and adding money to it until you have enough for the down payment.
One option you could look into is taking out a 401(k) loan. This is different from withdrawing from your Roth account early because you must pay the loan back, and it won’t decrease your 401(k) balance. Just be aware that you’ll have to pay interest like other types of loans.
One option to consider if you own a home and need to fund a purchase is a home equity line of credit (HELOC). This loan allows you to borrow against the equity you have in your home, but keep in mind that your home serves as collateral for the loan.
Bottom Line
Buying a home using funds from your Roth IRA may seem attractive due to rising home prices and the allowance of penalty-free withdrawals of up to $10,000 for first-time homebuyers. However, there are several potential disadvantages, including penalties and taxes and the loss of potential earnings. Waiting until you can afford the down payment or exploring financing options like a 401(k) loan or a HELOC may be better in some cases.