by Maurie Backman | Updated July 19, 2021 - First published on Oct. 21, 2020
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Mortgage rates are enticing right now. Should you raid your retirement savings to come up with a down payment on a home?
There's a reason so many buyers have been clamoring for homes, despite the fact that property values have risen nationwide and it's far more expensive to buy now than it was a year ago. Mortgage rates are extremely low, particularly for home purchases (refinance rates are also competitive, but slightly higher). From that perspective, it's a great time to buy.
The problem, of course, is inflated home prices. Now, you'll need even more money to make a 20% down payment. And to be clear, you should aim for that 20%: If you don't, you'll be stuck with private mortgage insurance (PMI), which is an added cost to your monthly mortgage costs.
If you're lacking the funds for a down payment, you may be tempted to take the money out of your IRA. But is that a smart move? Or one you'll ultimately regret?
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Normally, removing money from an IRA before turning 59 1/2 costs an extra 10% (an early-withdrawal penalty) on the sum you remove. But that penalty is waived if you're taking a withdrawal to buy a first-time home. To enjoy the waived penalty, you must withdraw $10,000 or less. If you and a spouse each have an IRA in your names, you can each take a $10,000 withdrawal -- leaving you with $20,000 combined to put toward the purchase of your first home.
Accessing money from your IRA could spell the difference between affording a home right now or not. But for the most part, removing funds from your retirement savings for homebuying purposes is a bad choice.
The purpose of saving in an IRA is to leave yourself with enough money to pay your bills in your later years. In that season of your life, you may have just your retirement savings plus Social Security to live on. And to be clear, Social Security generally won't suffice in paying your bills in full, so you'll need additional income to live comfortably. If you raid your IRA well ahead of retirement to buy a home, you'll have less money available to you as a senior, when you're apt to need it the most.
Another thing about IRAs is that they grow. That $10,000 in your IRA now could be worth much more when you retire, thanks to compound interest.
Let's say you take $10,000 out of your IRA at age 32 to buy a home. We'll imagine your investments in that account normally deliver a 7% average annual return, which is a few percentage points below the stock market's average. If you don't retire until age 67, you'll lose out on 35 years of growth. That means the $10,000 you withdraw today would've grown into $106,766 over time, so you'll actually be short that much money in retirement if you take that distribution, not just $10,000. That's a lot of potential retirement income to give up.
Tempting as it may be to raid your IRA to buy a home, you're better off saving for a down payment and leaving your long-term savings alone. If you're several thousand dollars shy of making a 20% down payment, try seriously cutting back on expenses in the coming months.
Right now, many people aren't traveling or spending a lot of money on socializing. If you commit to hunkering down for the winter, you might easily pocket a few hundred dollars a month. That can go toward buying a home. You can also try picking up a side job to boost your income. Of course, the economy isn't great right now, so that may not be the easiest thing to do -- but it's worth trying.
Another benefit to waiting: There's a good chance we'll see more housing inventory next year, especially if the pandemic ends or gets better early on in 2021. Once inventory picks up, home prices should start to come down. You may have an easier time making a 20% down payment even if you don't boost your existing savings all that much between now and then. And if you're worried about missing out on today's extremely low interest rates, worry not: There's a good chance rates will stay low for years.
You have your entire career to save up money to buy a home. Once you retire, your options for earning money will be limited. As such, you really shouldn't tap your IRA before your senior years arrive unless a true emergency strikes. The money in your IRA should be earmarked for retirement alone, and while you won't face a penalty for removing up to $10,000 to buy a home, you might still get hurt financially if you go that route.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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