Can you use your Roth IRA to buy a house? As it turns out, the answer is “yes, probably.” Let’s examine the rules and traps to avoid if you want to tap into this resource to get into a home.
What is a Roth IRA?
IRAs are tax-advantaged retirement savings accounts. Roth IRAs differ from regular IRAs in that the money you put into a Roth IRA is taxed when you earn it (and before you invest it in your Roth), so when you withdraw the money in retirement it is not taxed. What’s the advantage? The interest you earn in a ROTH IRA account is never taxed, even when you withdraw it.
As a result, the money is treated a little differently by the IRS.
Roth IRA Withdrawal Rules
The first thing you need to know is that if you’ve had your Roth IRA account open for more than five years, the rules around using it are more liberal than if you don’t.
The next is that if you are over 59 1/2 years old, you can withdraw funds all you like, for any reason, and without taxation or penalty.
If you are under 59 1/2 years old, you may withdraw the money you’ve contributed (but not what you’ve earned on that) from your Roth IRA at any time in your lifetime without paying taxes, but you will pay a penalty.
The Devil is in the Details When Withdrawing from a Roth IRA
It is simple to pull money out of your Roth IRA to help with the down payment, but the rules around it – both from the IRS’s point of view and the lender’s – are not.
If you are under 59 1/2 years old, the IRS will allow the withdrawal penalty-free if you are a first-time home buyer (meaning you have not owned a home for at least two years), and the total allowable withdrawal for this purpose is $10,000 or less.
While the principal you’ve invested in the Roth IRA (your contributions) can be accessed tax and penalty-free for this purpose, the interest can only be accessed if you have had the account open for at least five years.
If you simply pull money out of your Roth IRA without the intention of repaying it, the withdrawal should not affect your debt-to-income ratio, and therefore should have no impact on qualifying for your loan. If, however, you set up a repayment plan with your Roth IRA administrator, the payment you commit to will probably be counted against you.
What Will Lenders Accept?
For conventional loans (those sold to Fannie Mae or Freddie Mac), a lender will accept down payment contributions from a Roth IRA withdrawal. Conventional loans are prime credit loans up to $453,100 nationwide, and up to $679,650 in high-cost areas (2018 figures).
For non-conventional loans (often called “jumbo” loans), it is up to each individual lender. So, before taking that withdrawal, make sure you can use it in your specific circumstances.
Why You Should Use Your Roth IRA For Your Down Payment
If you can reach a threshold that reduces the cost of your financing, it could make a lot of sense to use your Roth IRA for your down payment. For instance, if that $10,000 extra makes the difference between paying mortgage insurance (MI) or not, it will probably save you way more money than you could earn on your account. Even if you can go from 90 percent loan-to-value to 85 percent, your mortgage insurance cost will be lower and you’ll save money on the interest rate, too.
And remember, you’re not “spending” that money; it’s not a cost. Rather, it is being invested in your equity, since the amount of your loan will be that much less, and your equity starting out that much more.
Why You Should NOT Use Your Roth IRA For Your Down Payment
On the other hand, you’ll find many arguing that it is critical to save as much money as possible for your retirement. Most Americans do not have enough savings upon retirement to live with dignity. It might make more sense to leave it in your retirement funds.
Moreover, once you invest it in the equity in your new home, that money is not very liquid. It is expensive, difficult and sometimes impossible to pull it back out to use it when and how you want. If your retirement savings are very thin, you may want to think carefully before depleting it and committing it to a very illiquid investment.
Ultimately, using your Roth IRA for a down payment is a very personal decision, but the good news is that IRS rules and lender underwriting guidelines allow you the option. It’s up to you to determine if it makes sense.