You Can Tap an IRA Early to Buy a Home. Should You?

You're allowed to take an early withdrawal from an IRA to buy a home. But whether that's a good idea is a different story.

A big reason so many people are struggling to buy homes today is that housing prices are very inflated. In fact, in May, home prices were up 17% from just a year prior.

Higher home prices don't just mean having to take out a larger mortgage. They also mean having to come up with a larger down payment.

For a conventional mortgage, you'll generally need to come up with a minimum of 5% down at closing, though many lenders require at least 10%. And if you don't put down 20% on a home, you'll be hit with private mortgage insurance, a costly premium that generally gets tacked onto your monthly mortgage costs, making your home more expensive.

If you're short on funds for a down payment but can otherwise afford to own a home, you may be thinking of tapping your IRA to get that money. But is that a good idea?

How early IRA withdrawals work

An IRA is an individual retirement account that has tax-advantaged treatment. When you put money into a traditional IRA, your contributions are tax free, so you reap some immediate savings. Because of that, the rules of taking withdrawals are very strict.

You're entitled to remove money from your IRA for any reason without penalty once you reach the age of 59 and ½. But if you take a withdrawal prior to that age, you'll risk a 10% penalty on the sum you remove.

There's an exception to this rule, however, for first-time home buyers. You're allowed to withdraw up to $10,000 from an IRA to use as a down payment for a first home purchase. Plus, if you're buying a home jointly with a spouse, and you both have an IRA, you can both withdraw up to $10,000 for a down payment, giving you a total of $20,000 that won't be subject to penalties.

Should you hit up your IRA to buy a home?

If you have money sitting in an IRA but don't have cash for a down payment, then tapping that account can be tempting. But before you go that route, you may want to consider postponing your homeownership plans or finding another way to save up a down payment.

The purpose of saving in an IRA is to ensure you have enough money to pay your living expenses in retirement. While you may be entitled to Social Security benefits when you're older, those benefits generally won't provide enough income to cover all of your bills. And without adequate savings, you might really struggle financially later in life.

The more money you remove from an IRA when you're younger, the less you'll have available later on. It's that simple. So for that reason alone, it's generally advisable not to tap an IRA to buy a home.

So how can you come up with down payment money? If you've tried cutting back on spending but it's still not enough to make a meaningful dent in your savings for a home, you may want to get a side hustle on top of your main job. Since the money from that gig won't be earmarked for existing bills, you can put all of it (minus what you owe in taxes) toward a down payment.

Another option if you're struggling with a down payment right now is to wait a bit to buy. These days, home prices are much higher than they'd normally be, so you'll need a higher down payment to keep up. If you wait a year to purchase a home, you may see home prices decrease. And if that happens, you might be able to get away with a lower down payment.

Saving in an IRA is a great way to set yourself up for a financially stable future. So don't risk your retirement to buy a home now. Tempting as it may be to access that money, you're better off leaving it alone and finding other ways to make your homeownership dreams a reality.