It’s a great time to buy a house, thanks to low mortgage rates. If you’re paying rent each month, you could find that your monthly mortgage payment would be lower than what you’re currently paying. But when it comes to home buying, one of the biggest barriers to entry is the down payment. How do you come up with 3.5 to 20 percent of the purchase price when you don’t have money to spare?

As you assess your finances, you may see a huge chunk of money in that retirement account you set up a few years ago. But the question, “Can I borrow from my IRA or 401(k)?” can bring different answers from one person to the next. In some cases, it may be a great way to grab a deal before mortgage interest rates rise. For some, though, the trade-off of having less money when you retire may not be worth it.

Don’t forget the effect that the current Covid-19 crisis is having on your retirement accounts right now, too – there’s a good chance your accounts have taken a dip recently, and the more time you give the market to recover, the better for your long-term retirement savings.

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.

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