Published October 29, 2012
Rock-bottom mortgage rates, affordable home prices and rising rents are enticing renters into homeownership. Some first-time buyers who lack the cash for a down payment and closing costs are turning to their retirement savings accounts for money to buy a house.
There are two ways you can leverage your retirement savings to buy a house:
"Right now, affordable prices and low interest rates offer an unusual opportunity to buy a home, so we do sometimes recommend that our clients borrow against their retirement," says Ben Barzideh, a wealth adviser at Piershale Financial Group Inc. in Crystal Lake, Ill. "Owning a home is an important way to build financial security."
Timothy Johnson, chief investment strategist with Lincoln Financial Advisors in Nashville, Tenn., says withdrawing money from retirement savings should be approached with caution. "While owning a house is a good idea, you should make sure you can reach your other objectives, too," he says. "A younger person will hopefully have a long time to rebuild retirement savings, so borrowing or withdrawing some of it isn't necessarily wrong, but they shouldn't take unnecessary risks, either."
Doug Benner, a senior loan officer with Embrace Home Loans in Rockville, Md., says borrowing from your retirement is much better than withdrawing money because you can repay yourself.
The rules about how you can leverage your retirement savings vary according to the type of investment.
"If you have a 401(k), you can borrow up to $50,000 or half of your vested balance, whichever is less," Barzideh says. "You are required to pay back the loan with interest, though, so you'll have another debt to pay that digs into your cash flow. Some 401(k) accounts require repayment within five years."
"One downside, though, is that you are less diversified in your investments if you are putting cash into a home instead of stocks and bonds," Johnson says. "The biggest problem is that if you leave your job, you might be forced to repay the loan in full because you are no longer a participant in the 401(k) plan. Some plans will let you continue to make payments, but others won't."
Johnson says if you don't repay your 401(k) loan in the allotted time, it will become an early withdrawal, triggering a 10% penalty and income tax payments on the loan amount.
If you have a traditional IRA, Barzideh says you can borrow up to $10,000 for a down payment without paying a tax penalty if you are a first-time homebuyer, although you will have to pay income tax on the loan. If you are married, each spouse can borrow up to $10,000 for a total of $20,000.
Johnson says withdrawing money from a traditional IRA is the least advantageous way to access your retirement savings because of taxes. He says withdrawing funds from a Roth IRA is the most advantageous because the withdrawal of any contributions to the account is tax-free and penalty-free.
"The problem is, Roth accounts are capped so that higher-income people cannot have them," he says. "That means you may not be able to replace the money in the account with future deposits."
Any withdrawal from retirement savings must be documented. "While you can wait until you have a home under contract to request a withdrawal or a loan, it's better to check out the rules of your particular account ahead of time, and get an estimate of what your repayment requirements will be," Benner says. "It can take three weeks to get the money from a 401(k) loan, plus you want it to be in your account for at least a week before closing, to make sure the funds are available."
Benner says 401(k) loan repayments are not included in your debt-to-income ratio for a conventional mortgage or a home loan guaranteed by the Federal Housing Administration or the Department of Veterans Affairs.
"If you withdraw funds from a traditional IRA, you must use the funds within 120 days for your down payment to avoid a penalty, so you need to time the withdrawal with your settlement date," says Barzideh.
While the best scenario would be to have plenty of cash without affecting your retirement savings, a withdrawal or a loan may be worthwhile for some homebuyers.
Reducing or eliminating retirement savings can be an alternative to withdrawing or borrowing from your accounts, but you'll be missing out on tax advantages and, often, an employer match with a 401(k) plan.
"You should at least try to save up to the employer match while you are saving for a down payment because otherwise you are throwing money away," Johnson says. "It's natural, especially for young people, to have to make compromises in their finances, but if you can't at least save a little toward retirement, then maybe you shouldn't be buying a house right now."
Barzideh says reducing retirement contributions means you lose the opportunity to build wealth over the long term, but he also says today's extremely low interest rates offer a "once-in-a-lifetime opportunity" to buy a house.