Let’s be real here. It’s no secret that saving up a down payment for a home is a tall order. Especially with the absolutely ridiculous prices these days! The median home in the U.S. is north of $400,000, meaning you’d need to save up a whopping $82,000 in order to fork over a 20% down payment on it. I don’t know about you, but how many folks do you know with 82k just sitting around?
Looking at a hefty down payment like this, it could be tempting to tap into your retirement accounts. Roth IRAs are a tempting choice, because there’s no penalty to withdraw contributions, and no taxes to worry about! But is taking money from your Roth IRA a really a good idea to buy a home? Will this move screw you over later in life?
In this post we’re going to walk through all the pros and cons of using your Roth IRA funds to help buy a home. We’ll also cover how to save for a down payment organically, as that might be a better option for most people.
Why Roth IRAs are Awesome…
A Roth IRA is a retirement investing superpower. Due to its unique tax advantages, the Roth IRA is one of the best retirement investing vehicles in existence. Here’s what makes it so awesome…
First off, Roth IRAs allow you to contribute money after tax. After that, you never have to pay tax on any of the money in that account ever again. Even if your account grows to be worth millions of dollars, you’ll never owe taxes on the contributions or gains in retirement. This is ideal for most folks because typically your tax rate is higher in retirement than it is now while you’re contributing. It’s also a great option for freelancers and small business owners, because it is not affiliated with any workplace retirement plans.
Another huge benefit – whatever money you put into your Roth IRA can be withdrawn at any time! There are no taxes or penalties for original contributions (any growth, interest or dividends you’ll need to wait until age 59 ½ to withdraw without penalty).
Even though we never suggest pulling cash from your retirement accounts at the first sign of trouble, it can be comforting to know that the money is there if you absolutely need it. Think of it like a backup emergency fund. It’s another line of financial defense!
It’s usually in your best interest to maximize a Roth IRA and grow the balance as high as possible. You do this by contributing the maximum allowable amount each year ($7,000 for 2024) and letting your investments sit for the long term. Assuming no contribution limit increase, and an 8% return on your money, you could become a Roth IRA millionaire after just 33 years!
Can you use money from your Roth IRA to Buy a Home?
“Is it even possible to use money from your Roth IRA to buy a home?”
Yes. One of the main benefits of a Roth is that your contributions can be withdrawn tax and penalty free, at any time, for any reason. You can even withdraw some of your earnings if you meet certain requirements without triggering any fees or tax consequences.
According to the “5 Year Rule,” you can withdraw money tax free 5 years after making your first contribution to your Roth IRA for specific reasons, one of them being to make a first time home purchase. You can take a qualified distribution up to $10,000 for your down payment.
Roth conversions and rollovers are also held to the 5 year rule. That’s a lot of money you can tap into if you’ve funded your Roth account using the backdoor Roth method, or rolling over funds from a Roth 401k.
OK, now let’s talk about the reasons why this perk is great. And some of the serious downsides of using your Roth IRA to buy a home too…
Pros and Cons of Using Roth IRA to Buy A Home
Now that we know you can use money from your Roth IRA to buy a home, let’s talk about whether or not you should. Just like most major financial decisions, there are positives and negatives to taking this approach. It’s never a one-size-fits-all answer.
Benefits of using a Roth IRA to buy a home:
If you’re considering using money from your Roth IRA to buy a home, here are some things that might work out in your favor…
No Penalties or Taxes
We covered this before – but it’s the main reason people think about tapping their Roth for down payment money… Roth IRA contributions can be withdrawn anytime, as well as your earnings up to $10,000 for a first time home purchase. As long as it has been at least 5 years since your first contribution, you’re free to take money out for that house.
Could Avoid PMI
If using your Roth IRA allows you to put 20% down on your home purchase, it can help you to avoid PMI, or private mortgage insurance. When you put down less than 20%, you’re viewed as a riskier borrower. PMI ensures that your lender doesn’t lose out if you are unable to make your mortgage payments.
On average, PMI can cost you around 0.6 to 1.8% of your loan amount each month, depending on your credit score and other loan factors. This can increase your monthly payment significantly! Avoiding PMI could save you from paying a few extra hundred dollars every month for multiple years.
Smaller Loan, Less Interest
Another benefit of using your Roth IRA to boost your down payment when buying a home is increasing your equity position. This lowers the loan amount, which in turn decreases the interest you pay. Ideally, after purchasing your home and holding on to it for a long period of time, you should experience meaningful appreciation. While primary residences aren’t the best investments, average appreciation for real estate is around 4% per year.
Downsides of using your Roth IRA to buy a home:
Not to sound like Eeyore, but it’s time to cover the negatives of tapping your Roth for a home purchase. Before you go emptying your Roth IRA to buy a home, you really should consider all these very serious downsides…
Penalties May Occur
When you take earnings out of your Roth IRA, you better double (and triple!) check your math. If you get the numbers wrong and withdraw more than $10,000 in earnings, or withdraw earnings before that 5 year wait period is up, you could be on the hook for tax consequences.
It happens more often than you think! People pull out funds, convert Traditional to Roth IRAs, and make moves with their money that spark serious tax consequences. It’s important to ensure you’re following all the IRS rules before messing with retirement accounts before you reach retirement age.
Miss Out on Potential Tax-free Earnings
Perhaps the biggest drawback of using money from your Roth IRA to buy a home is missing out on all that tax-free growth from investments!
The most powerful element of retirement investing is compound returns. This is when your investment returns ramp up, and now those returns are put to work in the market for you too. Compounding returns have rightly been called the eighth wonder of the world. And when all that growth is tax-free, it’s even more powerful when you reach retirement..
By taking money out of your retirement account early, you’ll miss out on all the compound interest you could be earning on that cash. This isn’t chump change! If you invest in index funds, your money likely doubles every 10 years. So everything you have in your Roth IRA now could potentially be DOUBLED if you left it invested instead of pulling it out. And remember, we’re talking about dollars that you’ll be able to draw down tax free in the future!
You Could Become “House Poor”
When you take money out of your Roth IRA to buy a home, you are essentially cutting your retirement fund off at the knees. Because you’re missing out on years of compound interest, you’ll have to work extra hard to build your fund back up. Even if you immediately get to work putting that money back into your Roth IRA, your contributions are limited each year, so it’s not quick or simple. It’ll take meaningful time to build that account back up.
Becoming “house poor” means putting all your money into a house, and not having anything for retirement. This is dangerous, because even if you own a house free and clear, you’ll need fully stocked retirement funds to pay for your living costs when you’re no longer working.
Plus, removing money from your retirement accounts is inherently risky. While it’s easy to say now that you’ll just work a little bit longer before retirement, or that you’ll invest more over the coming years, the ability to do both of those things is not guaranteed. Remember that your health is not promised down the line- you may not be able to work longer and delay retirement. And while you may be at the top of your career game now, layoffs and career changes happen, resulting in income fluctuations.
I’m not saying all of this to be a total downer. I just want you to understand the risk you’re taking when you draw on your retirement funds early before you decide whether or not to use your Roth IRA to buy a home.
Might Create a Bad Habit
Lastly, taking money out of retirement accounts to solve shorter term financial problems sends the wrong message. It’s like breaching a firewall. Doing it once could make it easier to start tapping your Roth IRA for other things down the road if it relieves other money issues.
But a Roth IRA is not a piggy bank, and it shouldn’t be treated as such. It’s a retirement vehicle – and one of the best available. Respect the Roth, people!
When you put money into your retirement accounts it’s best to pretend that this money doesn’t exist. Leave it invested for the next few decades until you retire. We would encourage you not to touch that money unless you need it for a serious emergency, such as a major medical event or a pending home foreclosure.
When using your Roth IRA to buy a home could make sense…
You should avoid taking money out of your Roth IRA to purchase a home in most cases. However, it could make sense if you have extensive retirement savings in other accounts, like a 401k at work. If you’ve over-saved elsewhere and can afford to take that money out of your Roth without necessarily needing to replace it, you can weigh this decision with that in mind.
Or if tapping a small amount of Roth funds will allow you to cross the 20% down payment barrier, helping you avoid thousands of dollars in PMI costs over the coming years, it’s also worth considering.
Alternatives to Using Your Roth IRA to buy a home
Tapping into your Roth IRA isn’t the only way to make your home purchase work. Here are a few alternatives to using your Roth IRA to buy a home.
Delay buying a home
I know you probably don’t want to hear this, but for most folks the best option is going to be to delay your home purchase, and to keep saving until you can put more money down. This way you’ll keep your retirement savings intact.
It can be frustrating to feel like you’re never able to save enough for your down payment, but I promise, it is possible! We’ll share a few tips later in this post to help you sock away more money for that home down payment.
Look for a house hacking property
There is one instance when paying PMI and putting less than 20% down can make sense. When you house hack, aka when you rent out a part of your home to a tenant, you turn your house into an asset that produces positive cash flow. The extra income you’ll earn from renting out your place can help to offset the cost of paying PMI.
Buy a cheaper home
If you really don’t want to wait to buy a home, perhaps you can start looking for cheaper homes. Opting to choose a more modest home at a lower price point means needing to save up less for a down payment.
Consider looking at places further from the city center, or that are simply smaller. You could always consider it a starter home, and in a few years move while holding on to it as a rental property.
Down payment assistance programs
If you’re having trouble saving up the down payment for a home, make sure you look into any assistance programs that you might qualify for. There are tons of programs out there that will help you to pay for your first home if you meet certain criteria.
Some programs are offered at the federal level, while others are more local and dealt with at the state or county level. A quick Google search will likely pull up dozens of down payment assistance programs, so make sure to poke around and see what kind of help you qualify for. If you’re already working with a real estate agent, you can also ask them to help you discover programs.
How to Save More For A Down Payment
If you decide to delay your home purchase, it doesn’t necessarily need to be for too long. Here are a few tips to save more money and accelerate your progress towards your home buying goal.
Sell your stuff
One way to earn some extra cash quickly is to sell all that stuff that’s been sitting around at the back of your closet. One man’s trash is another one’s treasure. \
Just toss that stuff up on Craigslist, eBay or Facebook Marketplace! You’ll help to declutter your current place, and have an easier time moving when the time comes.
Negotiate your bills
If you haven’t negotiated your bills in a while (or ever), clear your schedule this weekend!
Contrary to popular belief, we do have some control over how much we pay for things like cable, internet, cell coverage and insurance. Make a plan to call each of these companies and ask if there are any introductory promotions you can take advantage of. Sometimes they’ll be able to offer new customer deals even if you’re a longtime customer.
It may feel like switching companies might be a hassle, but it is 100% worth your time and energy if it helps you amass that home down payment more quickly.
Pay off debt
Having too much debt can make it difficult to save for a home purchase. If this is the case, it could be helpful to put your home buying plans on pause for a few months to pay down some of that high interest rate debt. Doing so will free up more of your monthly budget, making it easier to see progress on your down payment goals when you start saving again.
Start a side hustle
While it’s important to focus on saving more money when you’re trying to come up with a home down payment, earning more can play a major role in achieving your goal. Consider starting a side hustle to be able to save more cash each month towards your home buying goal. Or ask for a raise at work!
Switch to a bare bones budget
A bare bones budget is a budget which only includes your essential needs, like housing, transportation, food, utilities and any debt commitments. We often recommend making a bare bones budget as a safeguard against emergencies like job loss, but you can also switch to one temporarily to accelerate your progress on your biggest financial goals.
However, remember that living this restrictively is not sustainable over the long term, so be sure to switch to your bare bones budget with an end date in mind.
The Bottom Line:
Technically you can use Roth IRA funds to help buy a home, because contributions can be withdrawn penalty free and tax free anytime. But this doesn’t necessarily mean you should! Early withdrawals from your Roth IRA might give you temporary relief to buy a home, but it will likely stunt your investment growth in the long term and hurt your overall ability to achieve financial independence and retire comfortably.
If you can delay your home purchase and save up a down payment organically, this will always be your best financial option. Start by slashing whatever monthly expenses you can, stuffing all those savings into a high yield savings account, and wait until you have 20% of the home purchase price built up. I know it’s the slow and boring way, but it’s the safest way to get what you want now, and have enough savings for retirement down the line too.
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