Should You Use Your Roth IRA To Buy A Home?

The PropertyClub Team
Aug 20th 2020
Buying a home is a pricey endeavor that requires a lot of cash. One way to get funds for a downpayment is to withdraw from your Roth IRA. Here's how it works and how to decide if you should explore doing this.

The price of housing has increased steadily over the past 30 years, and it’s showing no sign of letting up. Getting funding for a home is also becoming a more challenging endeavor, with many lenders raising their standards higher every year. That’s why many people are now starting to look into alternative ways to fund a home purchase. One of the more interesting ways people have financed a home is through using the money in their Roth IRA. 

The idea of using money in your retirement account might make some balk, but it also could be an option to consider. It takes around seven years for the average person to save for a 20 percent down payment, after all. So, what’s the deal? Is this a good way to get the money you need to fund a home? Here’s the truth about this increasingly-popular funding method.

Understanding Roth IRA Withdrawal Rules

When you think about most retirement accounts on the market, the general rule is that you shouldn’t withdraw funds until you reach 59 ½ years of age. In some cases, you can’t withdraw it until you hit a minimum age. When you withdraw these funds early, you get hit with a tax penalty.

Roth IRAs are not like your typical 401(k)s or pension funds. They are set up entirely by you, and they are also added to your finances at a different time than most other retirement funds. 

You contribute to those funds after you’ve already paid tax on your earnings, which means that the rules for withdrawing those funds are slightly more relaxed. Even so, there are still rules you need to be aware of. Here’s what to know:

  • Technically, you can withdraw your contributed Roth IRA funds without penalty. There’s no cap on how much money you are allowed to take out, as long as it was money you paid into the fund. However, the investment earnings can be a little trickier. 
  • If you are buying your first home, you can withdraw up to $10,000 of your Roth IRA investment earnings without penalty. This is on top of the amount of money that you contributed. 
  • First time home buyers also get to avoid the 10 percent penalty, but the withdrawal will still trigger an income tax. So, while you won’t get walloped with tax penalties like you would in many other withdrawal situations, you will have to pay some. Even so, this would be far pricier to do with a 401(k). 
  • To withdraw funding from your Roth IRA, you will need to have an account that is older than five years. If you started your Roth IRA reasonably recently, this option is off the table. 
  • The funds that you withdraw from your Roth IRA have to be used to purchase a home or to rebuild one. If you want, you can also use the withdrawal to help a child, grandchild, or parent purchase their first home. 
  • You need to use the funds you withdraw within 120 days of the withdrawal. Otherwise, you may have a penalty on your hands. To find out what repercussions may be in store, it’s best to talk to a banker. 

Can You Use A Roth IRA To Withdraw Money For A Second Home?

The penalty-free status of a Roth IRA withdrawal only works if you are given “first-time homebuyer” status by the IRS. Most of the time, this means it’ll be your first house. However, there is another way you could get this status. 

According to the IRS definition, you’re a first-timer if “you had no present interest in a home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild.” 

It’s worth noting that married couples have to have both of their statuses be “first-time.” If one of you already bought a house or have an interest in a primary home, withdrawing from a Roth IRA won't make much sense. 

Is Withdrawing From Your Roth IRA To Buy A Home A Good Idea?

It’s great to know that you can withdraw money from your Roth IRA to fund a new home. But, just because you can doesn’t mean you should. In many cases, this can do more harm than good. 

There are still factors that may influence your decision to withdraw from your Roth IRA for a house payment. Here’s what you should think about when deciding on sourcing your down payment.

Will This Impact Your Retirement?

When it comes to your retirement, most people will not have a safety net to lean on. This means that you need to keep an eye on your retirement fund if you want to be able to rest during your Golden Years.

Withdrawing money means that you will lose out on the tax-free growth that a well-stocked Roth IRA will offer. It also means that you will likely end up with less money on retirement. This could put your future at risk if you don’t plan accordingly.

If you choose to use your Roth IRA, make sure that you can find a way to meet your retirement goals on time. Whether this includes increasing your 401(k) contribution or adding more to your IRA doesn’t matter. What matters is that you have a plan if it may put you in the red.

Is This A Matter Of Convenience?

Some people think that they should withdraw money from a Roth IRA for their down payment as a way to keep things convenient. This isn’t a good idea, primarily because it ends up costing more to the borrower in the long run. 

A Roth IRA is not a savings account. It’s also not meant to act as a short-term savings mode. It’s intended to be an account that continues to grow for decades. By removing money from it, you’re reducing your fund’s ability to grow and provide for you later in the future.

What we’re saying is that you shouldna let convenience be the driving factor in your decision. 

What Mortgage Options Are Available?

You no longer have to put down 20 percent in order to finance a home. Other mortgage options may be better suited to your financial situation, and most of them are geared towards people on a tight budget. 

VA loans, for example, don’t require a down payment. If you go for an FHA loan, you might be able to qualify for a loan with only 3.5 percent down. If you’re just using your Roth IRA to get a down payment for a home, then opting for a different mortgage style may be a better choice. 

Moreover, it’s important to remember that other options could help you get the home down payment you need. For example, people who have lower incomes may be able to find down payment assistance programs. Exploring available programs around you might be a better way to get the funding you need. 

Is It A Matter Of Timing?

Sometimes, the real estate market goes through extreme changes. Maybe, in recent months, there was a major crash. Or, perhaps you know that there is a specific window of time that will allow you to lock in a good price on a home in a neighborhood that you desire. These things happen.

During these times, the time that you apply for a mortgage can play a pivotal role in your life. With these situations, withdrawing money from your Roth IRA might be one of the better options out there. This is because it could potentially save you on interest and prevent you from getting “priced out” of your ideal neighborhood.

How Much Of A Priority Is Getting A House?

Different people have different priorities. If you are dead-set on getting a house and have it as your number one priority, you may want to consider dipping into your Roth IRA account to fund it. 

However, if you’re more ambivalent about your living situation, you might want to consider staying as a renter for a couple of years. It may give you the leeway you need in order to get a better financial standing.

Should You Ask A Finance Professional?

If you aren’t sure where you should focus your money or how you want to fund your next home, then talking to a professional makes a lot of sense. A professional financial planner (or even a good real estate agent) will be able to take stock of your finances and give you advice on if it makes sense for you to withdraw from your Roth IRA to buy a home. 

When choosing a professional to help you make the right decision, make sure that you take a look at their qualifications. In most cases, a financial planner or a real estate investment professional may be the best person to help you out.