Homeownership has long been the American Dream, but these days, younger workers are putting off buying homes for a number of reasons -- student debt being a big one. Still, there are plenty of millennials out there who have taken the leap into homeownership and are already enjoying the benefits of not having to rent.
Of course, buying a home is easier said than done, namely because you'll typically need a 20% down payment to avoid private mortgage insurance (PMI) and keep your monthly housing costs manageable. Given that the median U.S. home price is $200,000, the typical buyer will need $40,000, at a minimum, to purchase a place of his or her own. (And remember, there are also closing costs to worry about.)
So how do those millennials who own homes manage to pile up that sort of money? For some, it's a matter of cutting expenses for years and banking the difference. For others, however, it comes from none other than a retirement account, like an IRA or 401(k).
In fact, 30% of millennial homeowners today have raided a retirement plan to come up with a home down payment, according to Bank of the West's 2018 Millennial Study. Not only that, but 20% of younger workers who expect to buy homes plan to go the same route. And that's a move that could hurt them in the long run.
The danger of tapping your retirement funds
On the one hand, taking a retirement plan withdrawal to purchase a home might seem like a smart move. After all, why add to your mortgage debt or risk PMI when you have money of your own already sitting in an account?
The problem, however, is that any time you remove funds from a retirement plan during your working years, you're using money hat you won't have available for its intended purpose: retirement. And that could end up putting you in a precarious financial situation when you're older.
Remember, when you take an early retirement plan withdrawal, you're not just losing out on the principal amount you remove, but also its potential growth. So let's say your IRA typically earns 7% a year and you remove $10,000 at age 30 to purchase a home. If you were to leave that money in your account and let it grow for another 40 years, it would turn into $150,000. And that's a large chunk of retirement income to potentially give up.
Another thing to keep in mind is that, while IRAs do allow you to withdraw up to $10,000 penalty free to purchase a first-time home, 401(k) plans do not. Therefore, if you remove funds from the latter to buy property, you'll face a 10% early withdrawal penalty that applies to distributions taken prior to age 59 1/2. And that's a good way to throw out your money needlessly.
Coming up with your down payment
If you're intent on becoming a homeowner but don't have the savings on hand to cover a down payment, there are several options to explore before considering a retirement plan withdrawal. For one thing, review your budget and cut corners to free up more cash to put away. If you manage to reduce your current spending by $800 a month by downsizing your living space, giving up a car, and cooking all of your meals at home, you'll have close to $10,000 for a down payment in just a year's time.
Another option? Get a side hustle. An estimated 25% of younger adults with a second gig bring home over $500 a month as a result, so if you're willing to put in the effort, you might accumulate that down payment without having to touch your long-term savings in the process.
Finally, consider resetting your expectations as far as your first home goes. You have your whole life ahead of you to own property, and if you can't swing your dream home, it pays to look at a starter home that's more affordable. Either way, tapping your retirement funds ahead of schedule is a truly dangerous move, so if that's the only way you can manage your down payment, you might reconsider whether you're financially ready to buy a home in the first place.
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