Should You Use Retirement Savings to Buy a House?

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Buying a house has always been a part of the American dream. It not only adds prestige to the new owner but also some financial security. Homes for sale are now more expensive than ever, and getting enough money for a down payment can be difficult.

One way to get some of the money you need for a down payment would be to take it out of your retirement savings account. Before looking at houses for sale, here are some things you should know about using money from your retirement account to buy a house.

It Does Not Have to Be a First Home

Even though you can use money from your retirement account for a first home, it does not have to be for the first house you buy. You could have owned a house previously. The Internal Revenue Service (IRS) says you can qualify as a first-time homebuyer if neither you nor your spouse has had homeownership for the previous two years.

Taking Out a Loan From a Standard 401(k)

Instead of making a withdrawal from your traditional 401(k), you have the option to take out a loan against it. Getting a loan is cheaper than a withdrawal—especially if you are not yet 59½. If you are not yet 59½, you must pay a 10 percent early withdrawal penalty plus taxes on the amount taken out.

Not all employers give their employees a loan option. If you have an individual retirement account, you do not have the option to take out a loan, but you can get up to $10,000 for a home loan and not have to pay a penalty.

If that option is available, Bankrate says you can borrow up to $50,000 from a 401(k) or up to half of the account. Most likely, you must pay it back within five years plus interest, but some companies may give you longer—possibly up to 25 years. Forbes mentions that you may not get the money until after closing on the home. The interest goes back into your account—but you must pay twice the taxes on that money when withdrawing it.

A negative possibility is also something you must know before making this move. RamseySolutions says that if you quit your job, get fired, or laid off, you must pay the balance before the next April 15, or the government will consider it an early withdrawal. Taxes will be due.

There are two advantages of getting a loan from your 401(k). Experian says that the loan will not be considered in your debt-to-income (DTI) ratio that lenders always look at. Usually, they do not want a ratio higher than 36 percent, but some may allow a ratio up to 43 percent.

A second advantage is that a loan from your 401(k) will not affect your credit score. It means that it will not hinder your ability to get a loan.

A Roth 401(k) Withdrawal Advantage

If you have a significant amount in a Roth 401(k), you have an advantage when taking money from the account. All money that you contributed to your Roth account has been after tax. That means that there will be no taxes due when you withdraw money for a downpayment for a home. Forbes mentions that you not only can withdraw your initial contributions but also many people can take out an additional $10,000 and not owe any taxes.

Remember that you cannot take money out of a 401(k) without a penalty until you have had the account open for five years. The money withdrawn must also have been in the account for five years—you cannot withdraw the money you put in the previous year without a 10 percent penalty. Other than for a home loan, withdrawals have a 10 percent penalty if you are not 59½ yet.

Tips for Buying a Home

Before you take money out of your retirement account, you should consider whether you can afford it. It could create a problem in two ways. First, if you take a loan from your retirement savings, you should decide if you have enough time to replace it before you retire. It means lost time to rebuild a sizeable amount, which could affect how comfortable your retirement will be.

You also need to remember that people live longer today than they did just 15 years ago. The result is that more money is needed for retirement, and medical expenses after you turn 65 can be costly—possibly including the need for long-term care or nursing home care.

A second consideration—just as important—is that you need to decide if you can make loan repayments and pay the mortgage costs on top of it. If any repairs or maintenance issues come up—you will be the one responsible to pay for them.

A Better Retirement Choice

People who do not have a lot of money in their retirement accounts need to rethink getting a mortgage that will go into their retirement years. Ideally, you want to enter retirement with as little debt as possible, enabling you to enjoy your retirement savings more.

Another option, Investopedia suggests, is to continue paying on a mortgage in retirement. This option can enable you to tap into your home’s equity and reinvest it, which could give you another source of income. You can also deduct any interest on your mortgage.

Renting a house for your retirement years or an apartment can be a much sweeter deal if you do not have much in savings. You will not have maintenance costs to deal with and no sudden repair bills.

Talk to a financial advisor before deciding to buy a house with money from your retirement savings account. They can run the calculations and possibly show you other options.

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