Purchasing a house is likely to be one of the costliest transactions you’ll ever make. Given the magnitude of this investment, more than 90% of home buyers utilize a mortgage to fund their purchase since they can’t afford to pay in cash outright.
In the majority of cases, mortgaging property is standard practice. However, there are rare instances where highly economical buyers save for multiple years to make a cash purchase or find affordable properties in low-cost areas.
As for the rest, the primary recourse is to take our chances with mortgage lenders and manage to accumulate a significant down payment. An accepted guideline suggests making a down payment of at least 20% on a residence. But, even this can represent a significant financial outlay depending on the home price.
Considering a home priced at $250,000, abiding by the 20% rule would necessitate a $50,000 initial payment. Thus, whether your goal is the commonly suggested 20% or less, amassing the necessary funds for a down payment can be quite stressful. Some individuals circumvent this hurdle by resorting to their retirement savings to finance their home purchase.
From a procedural perspective, when you extract funds from your 401(k), you’ll pay yourself interest, typically about one or two percentage points over the prime rate. Generally, you can borrow up to half of your retirement balance or a maximum of $50,000. Loans generated in this fashion should usually be repaid within five years. However, in certain scenarios, your employer may allow up to 15 years if the funds are allocated for home purchase.
If you’ve invested in an IRA, you’re permitted to withdraw up to $10,000 from the account for your down payment, provided you haven’t owned a home as your primary residence within the past two years. Although this withdrawal is typically penalty-free, it is subject to taxation. Conversely, withdrawals from a Roth IRA escape taxation, as the money has previously been taxed. But if your withdrawal exceeds the $10,000 homeowners’ exemption, a 10% penalty applies to the surplus amount.
Before diving into these measures, mull over their potential impact on your retirement fund and the consequent delay in your retirement plan. Note that a withdrawal of even $10,000 – $50,000 could have long-term impacts, as you’ll lose potential earnings and possibly see a shortfall in your retirement fund. Tools like a retirement calculator can be used to evaluate the implications of borrowing from your retirement fund on your long-term financial status.
Additionally, reflect on the added fiscal strain. For example, borrowing from a 401(k) aids in home purchase, but the loan must be repaid with interest, which can be burdensome. Non-repayment of loans leads to the amount being treated as taxable withdrawal. Alongside, you’ll also face a 10% early withdrawal penalty if you are below the age of 59 ½.
Consider the duration you plan to retain the property for as well. For long-term home-owners who plan to utilize their equity as supplementary retirement income, tapping into retirements funds might not be a significant concern. But, for first-time buyers likely to relocate within five years, borrowing from retirement accounts could lead to substantial financial stress.
In conclusion, borrowing from retirement savings to acquire a property presents more cons than pros. To secure a comfortable retirement and preserve financial independence, it is advisable to leave your retirement savings untouched. Instead, consider alternatives such as an FHA or VA loan that require a smaller down payment, first-time homeowner grants, purchasing a less expensive starter home or cutting down other expenses. Avoid the rush to buy a house; taking a while longer to save could offer a greater sense of security and ensure you purchase a house well within your means.
As the adage goes- ‘patience is a virtue’, consider it before dipping into retirement funds to finance home purchase.
