Should You Use Your Roth IRA Money to Buy a Home?

using your Roth IRA to buy a home

Using your Roth IRA money to buy a home sounds like a spectacular idea, does it not? You can use your Roth IRA money to buy a home so that you don’t have to bother with details such as saving money, and the IRS says it’s all right. Therefore, it must be a wonderful idea. This is your money, after all, so you should be able to do with it as you please. However, that is simply not the case. Sure, it’s your money. Sure, the IRS (maker of all the rules of taxes) says it’s all right to use your Roth IRA money to buy a home. Sure, now you can buy now instead of waiting a year until you’ve saved enough for a sizable down payment. Sure; it’s all good.

Except for the small fact that it is not all good; be very, very careful using your Roth IRA money to buy a home. It’s not always the amazing idea it seems upfront. Low interest rates and a total buyer’s market are a big draw right now; trust me, I know. However, they will not last forever. I can attest to this, personally. Only a year ago my husband and I were able to upgrade by buying our second home, a much larger home that better fits our family of 6, for a price that was an absolute steal. It’s been a year, and our home has been appraised now for almost double what we paid. Prices are going up, interest rates are going up, and sellers are very happy about the change in the housing market.

Buyers, on the other hand, are less than thrilled, and they are looking to get their hands on property as soon as possible. Now is the time to buy. Interest rates are skyrocketing quickly and home prices are becoming more and more expensive. So that means it’s time to start using your Roth IRA to buy a home, right? Wrong; don’t listen to the IRS and their tax rules when it comes to buying a home. We are here to tell you that using your Roth IRA to buy a home is not the grand idea it seems to be, and we will tell you precisely why that is the truth.

Contributions and Earnings

A Roth IRA account is one that has both contributions and earnings in it; you contribute and it earns. Seems pretty simple, right? Even those of us without a love of even basic math can see that this is not a difficult equation. Here is what you need to know about using your Roth IRA to buy a home. The IRS is fine with you taking out the contributions you’ve made to your Roth IRA at any point in time. This is money you already paid taxes on, after all, so it’s free for you to use at any time. It is technically a retirement account, but the IRS doesn’t care if you have the funds to retire when you are old enough, so use it and abuse it all you want.

Here is where it gets a little bit tricky and the IRS gets you. Not all that money is contributions. There are earnings in that account, and those you have not paid any taxes on as of yet. If you withdraw funds from your Roth IRA to buy a home, you will find that you might be taking out both contributions and earnings, and that means you’re paying even more on taxes when you take the money out of your account. You’ll have to be able to take out only contributions, and it’s a slippery slope. You’ll need to go through a ton of paperwork, contact the IRS and your account and you will find it imperative to dig up a number of very specific documents between now and withdrawing funds so that you can use your Roth IRA to buy a home.

First Time Withdrawal

There are, as always with the IRS, stipulations in place designed to help you if you plan on using your Roth IRA to buy a home. You can use the earnings in this account to buy a home without paying any additional taxes, but you do have to meet very strict requirements.

  1. The Roth IRA must be a minimum of 5 years of age
  2. You must use the funds in the account that you withdraw within 120 days of removing the funds from the account
  3. Do not remove more than $10,000 worth of earnings from your account
  4. You must be a first-time homebuyer

If you meet each of these qualifications, you are eligible to remove as much as $10,000 in earnings from your Roth IRA to combine with your contributions. This allows you to now purchase a home with an even bigger down payment so that you have more equity in the home and so that you do not need a mortgage quite so large. It helps, too, if you plan on using your Roth IRA to buy a home if both you and your spouse have an account of this nature you can tap to remove funds for a down payment.

If you are using your Roth IRA to buy a home and you are a first-time homebuyer, you might be the one person who does not need to be so wary of using your Roth IRA to buy a home. The good news is that you aren’t actually required to be a real first-time homebuyer to take advantage of this program. What we consider a first-time homebuyer is a person who has never before owned a home at all. What the IRS considers a first-time homebuyer is someone who has not owned a home in 24 months.

The Long Term Effect

Now that you are particularly sold on using your Roth IRA to buy a home, let’s get down to business; we still don’t recommend it. Even if you meet the above-listed qualifications and can remove your contributions and your earnings from your Roth IRA without paying additional taxes, we just don’t feel it’s the best idea. You know that old saying, “You have to live like no one else today so that you can really live like no one else tomorrow?”

That is true in this case. When you contribute money to a Roth IRA, you pay taxes on that money. This means that one day you will retire and you will never have to pay taxes on those earnings. This means you’ve got a lot of money just sitting around you can use anytime you want, for anything you want, without ever paying another dime to use it. That’s appealing. That’s why a lot of people choose not to use their Roth IRA to buy a home. Let’s do some math.

If you take out a small $10,000 withdrawal from your earnings, you will not have to pay taxes on it. However, that money could grow over the next several decades. Let’s say you leave that money alone for 40 years instead of using your Roth IRA to buy a home. That means you’ll have turned that $10,000 potential down payment into a $150,000 savings that you don’t have to pay taxes on. That’s all tax free; that’s a lot of money to have without paying any taxes on it. If you are married and you and your husband or wife do the same thing, you could have $300,000 sitting around when you retire.

If you take that $10,000 out right now to buy a home and you do not pay taxes on it, what’s left? You might have a house that increases in value, but is it going to increase in value more than $150,000? Probably not; and it’s no longer tax free if it does.

Many financial experts talk about bigger mortgages and how they are not necessarily the worst thing that ever happened; and we have our own opinion on that. One financial expert states that if you have a mortgage interest rate less than 5%, you should save your cash, finance as much as possible and pay it off slowly so that you can deduct your mortgage interest on your income tax returns each year. Of course, owing a large mortgage is never a good idea if you want to live a debt-free lifestyle, but this is something that is very personal to each individual and family – and financial situation.

Finding Financial Help Elsewhere

Perhaps you do not want to fall into the trap of using your Roth IRA to buy a home, and that’s all right. If you don’t want to do this, then don’t. But there are other financial means out there that can help you buy a home. Of course, the best way to do it is to save up enough to put down a 20-30% down payment on a home and go from there. However, if you are particularly strapped for cash and not comfortable using your Roth IRA to buy a home, you can do something else.

Many states offer first-time buyer programs that allow buyers to finance homes with small down payments (as low as 3.5%). However, you will then pay private mortgage insurance, which is very expensive, until you have more than 80% equity in your home.

Another option to prevent you from using your Roth IRA to buy a home is to minimize your contributions for a year so that you can save money for a down payment. It’s a good idea to put down at least 20% so that you do not have to pay private mortgage insurance. It’s a lot less expensive to minimize contributions than to remove them from a Roth IRA, and you still get to buy yourself a new home. A few other simple tips that will help you with your home buying adventure:

  1. Buy what you know you can afford, not what the bank tells you that you can afford
  2. Consider additional expenses when determining what you can afford (utilities, insurance, maintenance, HOA fees, etc.)
  3. Go with an inspection
  4. Take your time

The process of buying a home is stressful enough as it is, you don’t need to add using your Roth IRA to buy a home to the mix. You don’t want to lose that retirement income, that potential for growth, and you certainly do not want to pay taxes on this money. It’s not an idea you want to bother with.

Photo by Getty Images