Should You Borrow from Retirement to Buy a Home?
| Photographs By Dean Mitchell
Buying a home is one of the most expensive purchases you’ll ever make. It’s so expensive that over 90% of buyers actually take out a mortgage and finance their home. They can’t afford to pay cash.
Getting a mortgage is pretty normal. There are some unique cases where buyers are super frugal and save for several years to buy a home in cash. Or they may live in a lower-cost-of-living area that makes the purchase more possible.
The rest of us are stuck with trying our luck with a mortgage lender. Plus, coming up with a decent down payment.
A good rule of thumb is to put at least 20% down on your home, but even that can be a huge sum of money depending on the home you’re trying to buy.
If the home you want costs $250,000, you’d have to put $50,000 down to honor the 20% rule. Whether you’re aiming to put 20% down or not, coming up with your down-payment money may be stressful.
One option some people take is borrowing from their retirement savings to buy their home.
How it works
Borrowing from retirement to buy your home has its pros and cons (which I’ll get into in a bit), but here’s how the process actually works.
When you borrow from your 401(k), you’ll pay yourself interest. The rate is usually around one or two percentage points above the prime rate.
In most cases, you can borrow up to half of your retirement balance, or a maximum of $50,000. Loans usually need to be repaid within five years. but your employer may give you up to 15 years if you use the money to buy a home.
If you have an IRA, you can actually take up to $10,000 out of the account to use for your down payment. This is so long as you have not owned a home as a primary residence within the past two years.
You can withdraw this money penalty-free, but it will be subject to taxes. If you withdraw funds from a Roth IRA, they won’t be subjected to taxes (since the money was already taxed). But, if you exceed the $10,000 homeowner exemption, anything additional will be charged the 10% penalty.
If you’re thinking about borrowing from retirement or taking money out of your IRA to help fund the down payment for a new home, here’s what you should consider first.
This could delay your retirement
If you borrow from retirement to buy a home, the huge downside is that you’re taking money away from your future retirement. Conventional wisdom tells us never to touch the money in a retirement account, and for good reason.
Depending on your age and retirement goals, now may be a crucial time to stash money away and prepare for the future.
If you take $10,000 to $50,000 out of your account, that could make a big difference even if you plan on paying it back over time. You’ll miss out on earnings, and this could leave a gap in your nest egg.
If you withdraw from your IRA, you may not even pay the money back since there’s no strict rule that you have to.
Make sure you decide when you’ll realistically wish to retire and how taking money from your retirement account could benefit or delay your plans. Use a retirement calculator to test out different scenarios and see how much borrowing from retirement could really set you back in the long run.
Added financial strain
When buying our first house, I was presented quite a few grant opportunities from our lender. I specifically steered clear of grants that would require my husband and me to pay back the full amount over time.
This sounded like a loan and I didn’t know if we’d be able to handle the financial strain. Buying our first house was a new experience. We already knew we’d be spending more on the mortgage than we had on rent in the past.
Factor in expenses like home maintenance, repairs, added bills, and various financial goals, and I didn’t want to take on another responsibility.
Sure, borrowing from your 401(k) can help you get the house you want, but you have to pay all that money back plus interest.
If you fail to repay the money from your 401(k), it will be treated as if you made a taxable withdrawal from your plan. Plus, you’ll have to pay a 10% early withdrawal penalty if you’re under age 59½. I don’t think anyone really wants a mortgage plus a loan to repay the down payment.
A down payment is supposed to provide you with some initial equity as a homeowner. If you have to borrow money to make a down payment, you probably can’t afford the home you’re trying to buy. It will become a burden sooner or later.
Think about how long you plan to keep the home
Borrowing money from retirement to buy a house may seem like a solid plan for buyers who will depend on equity in their home as supplemental income during retirement.
If you plan on owning your home for a long time and can use the equity as a way to diversify your retirement portfolio, it may not be a huge deal to borrow or withdraw some funds from your retirement account.
However, if it’s your first home and you may move in the next five years, you shouldn’t touch retirement money. Again, repaying the withdrawal can be too much of a financial burden. This is especially true if you plan on selling in the future and making a profit.
The best time to sell is when you have enough equity in your home. It will take longer for you to obtain enough equity and feel financially stable if you borrowed money for your down payment.
In my opinion, the cons outweigh the pros when it comes to deciding whether to borrow money from retirement in order to buy a home. If you truly value financial independence and want more options as you get older, you shouldn’t touch your retirement savings.
Plus, there are other ways to find money to put down on your home. You can make a smaller down payment by using an FHA or VA loan. Another idea is to apply for first-time homeowner grants that will provide down-payment assistance.
You can also start with a smaller, more affordable home, or lower some of your other expenses. Also, try not to be in a major rush to buy a home. If you need to take an extra year or two to save, you’ll feel much more secure. You’ll know you can finally buy a house you can afford with ease.
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