Deciding whether to borrow from your retirement savings to finance the purchase of a home is a significant financial dilemma that many individuals face. This strategy might seem appealing, especially when considering the potential to own a home sooner or to manage a financial gap in purchasing your dream property. However, tapping into retirement funds carries considerable implications for your long-term financial health and retirement readiness.

Before making such a pivotal decision, it's important to weigh the immediate benefits of homeownership against the potential impact on your retirement nest egg. Borrowing or withdrawing from retirement accounts like a 401(k) or an IRA can offer a temporary solution for acquiring a home, but it also reduces the amount of money working for you in the market, possibly derailing your retirement plans. This article explore the pros and cons, rules, and long-term effects of using retirement savings for buying a house, helping you navigate this complex decision with greater clarity and understanding.

Retirement savings loans for home buying

Can you borrow from an IRA to buy a house before you turn 59 ½? Yes, but only if you’re buying your first house. You can borrow from IRA accounts without paying the 10 percent tax and penalty, as long as both you and your spouse qualify as first-time homebuyers.

But even if you’ve owned a home, you aren’t excluded. For this purpose, the IRS defines a first-time homebuyer as anyone who has not owned a home in the past two years. If you qualify, you’ll be limited to the maximum lifetime penalty-free withdrawal of $10,000 per person. (There’s some wiggle room with Roth IRAs, as you can also withdraw your contributions penalty-free, but you’re still limited to withdrawing $10,000 of your gains.)

Borrowing from a 401(k) can be much easier, as long as your plan allows it. You’ll need to check with your plan administrator to determine the exact rules that apply to loans. This information would have been spelled out in the terms you agreed to when you set up your 401(k). But the IRS will restrict every 401(k) loan to 50 percent of the amount you have vested or $50,000, whichever is lowest.

Retirement savings: borrowing versus withdrawing

Even if you can take a loan from an IRA or 401(k), it doesn’t mean you should. It’s important to note that you’ll need to be able to repay the loan within the term, which is a maximum of five years for 401(k) loans.

If you tap into your IRA, it won’t be considered a loan but a withdrawal, so you’ll have no obligation to put the money back. Due to the IRS’s IRA loan rules, though you will have only 120 days to put the money toward purchasing your home before the 10-percent penalty kicks in.

401(k) borrowing requirements

If you’re thinking about cashing out your 401(k) to buy a house, it’s important to make sure you’ll be able to repay it within five years. Calculate all your expenses, including the amount of your mortgage payment, and make sure you can afford that extra payment to your 401(k). You’ll also have to pay interest on the money you borrowed.

For 401(k) accounts connected to an employer, there’s typically wording that says you have to repay the full amount immediately if you leave your job. If you hit the five-year mark or leave your employer, the amount remaining to be repaid would be considered a plan distribution and taxed at ordinary income rates. Unless you’re 59½, you’d also face a 10-percent additional tax on that amount.

Using money from an IRA

Although the answer to, “Can you borrow against an IRA?” is, “No,” you can withdraw the amount you need if you and any co-buyers haven’t owned a house in the past two years. If you have owned a house and take money out for a home purchase, the entire balance of the IRA becomes taxable income.

If you’re thinking about using an IRA to buy a house, it might be worth looking into alternatives, especially if you don’t qualify as a first-time homebuyer. The IRS doesn’t allow loans from any IRA-based plan, including SEPs, SARSEPs, and SIMPLE IRA plans. However, if you have a government pension or any annuity plan, it’s worth checking to see if you may be able to take a loan that you can repay in five years.

It’s important to note that rules regarding an IRA apply specifically to Traditional IRAs. If you have a Roth IRA, the money you contributed went in after tax. That means you can withdraw your contributions at any time without paying penalties or taxes on the funds (there would still be a penalty and tax on gains if you’re not 59 ½).

Qualifying for a retirement savings loan

Even if you try to use an IRA to buy a house or take a loan against your 401(k), you may face some obstacles. If you’re married, your spouse will likely be required to give consent before a loan will be issued. Also, the five-year rule is the maximum amount set by the IRS, so your plan may have a shorter timeline for repayment. In addition, 401(k) loans are limited by law to either $50,000 or ½ of the account balance – whichever is lower.

Rules regarding a loan against IRA and 401(k) accounts don’t apply to everyone, though. If you’re 59½, you can take the money out without the extra 10 percent penalty. The penalty can also be waived for those who are totally and permanently disabled.

Home loans reduce contributions

It’s important to carefully consider whether a loan against your retirement account is a good idea. With a 401(k) loan, you’ll have a relatively short timeline to repay the loan, with interest, in addition to all the expenses you’ll have with a new home. Not only will you lose the money you’re paying on interest, but you’ll only earn interest on the smaller amount remaining in the account.

Since you can’t borrow against IRA accounts, it’s especially important to consider what you’ll lose. First-time homebuyers who qualify will take the amount out as a withdrawal, which means you won’t have that money waiting for you when you retire. You can put the money back later, but you’ll also miss out on the interest you would have earned during that time.

Bottom line

In some cases, withdrawing money from a retirement account can make better financial sense. Buying a house can be part of a larger financial plan that sets you up for success now and into the future. But you shouldn’t necessarily be looking at your retirement funds as a piggy bank to raid. We recommend you speak to a Certified Financial Planner® who can look at your unique financial situation and help you find the best way to pay that 3.5 percent to 20 percent down payment.

Frequently asked questions

Is it possible to borrow from my retirement savings to buy a house?

Yes, it is possible to borrow from certain types of retirement accounts, like a 401(k) or an IRA, for the purpose of buying a house. However, the rules and penalties for doing so vary depending on the account type and other factors.

What are the rules for borrowing from a 401(k) to buy a house?

If your 401(k) plan allows loans, you may be able to borrow up to 50% of your vested account balance, up to a maximum of $50,000, to purchase a home. These loans typically need to be repaid within five years, although terms may extend longer for home purchases. Interest on the loan is paid back into your 401(k).

Can I withdraw from my IRA to buy a house without penalty?

Yes, first-time homebuyers can withdraw up to $10,000 from an IRA without facing the usual 10% early withdrawal penalty. For a Roth IRA, you can withdraw your contributions (but not earnings) tax- and penalty-free for any reason, including buying a home. However, income taxes may still apply.

Are there any downsides to borrowing from my retirement savings?

Borrowing from your retirement savings can significantly impact your retirement nest egg, especially due to lost compounding interest and investment returns. Additionally, if you leave your job, you may need to repay a 401(k) loan in full or face taxes and penalties.

What should I consider before borrowing from my retirement to buy a house?

Consider the impact on your retirement savings, the terms of repayment, potential penalties and taxes, and alternative financing options. Weigh the immediate need for a home against your long-term financial security.

How does repaying a 401(k) loan work?

Repayments on a 401(k) loan are typically made through payroll deductions, with both principal and interest paid back into your account. Failure to repay the loan can result in it being considered a distribution, subject to taxes and penalties.

Does borrowing from retirement savings affect my credit score?

Loans from your 401(k) do not appear on your credit report and do not affect your credit score. However, defaulting on the loan can lead to taxes and penalties that might indirectly impact your financial stability and creditworthiness.

Are there alternatives to borrowing from retirement savings for a home purchase?

Yes, consider other home financing options, such as conventional mortgages, FHA loans, or down payment assistance programs, which may offer more favorable terms and less impact on your long-term financial plans.

Is it better to borrow from a 401(k) or withdraw from an IRA for a home purchase?

This depends on your individual circumstances, including your age, the amount you need, and your ability to repay. Borrowing from a 401(k) offers the advantage of repayment, whereas an IRA withdrawal does not need to be repaid but may incur taxes.

Who should I talk to before making a decision?

Consult with a financial advisor, tax professional, or mortgage lender to understand the full implications of borrowing from your retirement savings for a home purchase. They can provide personalized advice based on your financial situation and goals.

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