Today’s low interest rates make buying a home incredibly tempting, especially if you’re being hit with annual increases in rent. But finding money for a down payment can be tough, especially if you don’t have much wiggle room in your budget.

One option is to tap your retirement savings. This approach has plenty of pros and cons, and you’ll want to consider it carefully before moving forward. If you do decide to use retirement savings to buy a home, be sure you understand all the rules, regulations and fees first.

Another Option to Consider

Before you cash out retirement savings to buy a home, consider one option: halting your monthly retirement savings in order to save for a home.

This option will keep you from paying penalties and fees for an early withdrawal and will keep your retirement savings intact. If you’re putting a significant amount of money into retirement savings each month and can wait a while before buying a home, this is probably your best bet.

But if you’re not putting much into retirement, or if you started saving young so that you have extra money available in your retirement account(s), read on to find out how to use it for a down payment.

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Pros and Cons of Tapping Retirement Accounts

First, you should know that the choice to use retirement funds for buying a home is personal. Whether this is the best option for you depends on your retirement savings, your financial goals and your homebuying situation.

This basic list of pros and cons can help you begin to think through this decision, but you may want to talk to a financial professional who can give you a more thorough evaluation of your options based on your unique circumstances.

  • You can buy a home more quickly. If you’d need months or even years to save a proper down payment, using retirement can get you into a home — and out of an expensive rental — faster.

  • The money is relatively easy to access. Depending on your employer and the type of retirement account you use, the money in your retirement fund is probably pretty easy to get to, especially if you’re using it to buy a home.

  • If you take out a loan, you’ll repay yourself. If you take a loan against your retirement account for your down payment, you’d pay yourself back, usually at a pretty low interest rate.

  • Obviously, your retirement savings could take a significant hit, which is made worse when you look at the compounding interest you would have gained on that savings.

  • If you take out a loan against your retirement account and lose your job, you may have to pay back the loan immediately.

  • You may be hit with a serious tax bill if you don’t take your withdrawal properly, and sometimes you won’t be able to avoid taxes, even if you do take the money out correctly.

Using Money from a 401(k)

If you have a 401(k) account through your employer, you’ll need to talk with your human resources department about your options. Generally, you can use one of two options: a loan from your account or a hardship distribution.

Loan from Your 401(k)

Lending rules for 401(k) plans differ from one plan to the next, but many allow you to borrow from your plan. Check your plan documents to see if loans are permitted (or ask your human resources representative).

Usually, you can borrow up to half of your vested account balance, up to $50,000.

When you borrow from your 401(k), you’ll have to make repayments with interest, usually 1-2 percent, depending on your plan. Your repayments go back into your account, beefing your retirement savings back up.

Your 401(k) loan has to be repaid within five years, so you’re not missing that much time and compounded interest in the grand scheme of things, especially if you’re relatively young. The repayment will be done through level payments at least once a quarter for the life of the loan.

As noted above, the riskiest piece of a 401(k) loan is that it may have to be paid in full within 60 days if you quit or lose your job. No job is bulletproof, and if yours is unstable, you may want to avoid this option.

Hardship Distribution

Some 401(k) plans (again, check with your human resources department on your particular plan) allow hardship distributions. These are limited to the elective deferrals in your account and don’t usually include any interest income. This means that unless you’ve been saving a lot or for a long time, there’s probably not that much money available for this type of distribution.

However, if you have an immediate and heavy financial need related to buying a principal residence (i.e., your first and primary home), you may be eligible for a hardship withdrawal.

Also, you’re not eligible for a hardship distribution if you can cover a down payment by liquidating other assets, taking other nontaxable loans or distributions from the account, or ceasing elective contributions to your plan. Basically, to take a hardship distribution, you have to prove it’s your only option for putting a reasonable down payment on a home.

A hardship distribution from your 401(k) will still require that you pay taxes at the ordinary income rate, because the money wasn’t taxed before it went into your account. But you won’t have to pay the extra penalty associated with early withdrawals.

Clearly, this is a last-ditch option for tapping into your 401(k) account, and it may also involve lots of extra paperwork and scrutiny. Still, it’s there if you really need it.

Using Money from an IRA

If you qualify as a first-time homebuyer, you can take up to $10,000 out of your IRA account to pay for the down payment and/or closing costs to buy, build or rebuild a home. You’ll still have to pay taxes on any pretax IRA investments (i.e., those in a traditional, rather than a Roth, IRA), but there won’t be a 10 percent early withdrawal penalty to worry about.

You can use money in an IRA to pay first-time home acquisition costs for yourself, your spouse, your or your spouse’s child, your or your spouse’s grandchild, your or your spouse’s grandparent or another ancestor. (In other words, if someone wants to give you a down payment gift, they can use up to $10,000 of an IRA to do so, as long as you’re a first-time homebuyer.)

Under IRS rules, a first-time homebuyer is anyone who hasn’t owned a home within the last two years. So, really, this could be your second or third home, as long as you’ve not owned a home within the past two years. Your spouse also needs to qualify under this rule if you’re buying a home together.

Also note: if you’re eligible for a 401(k) distribution, say you left a job with a company 401(k), you could roll the money into an IRA and then use it for a down payment to avoid extra fees and penalties. This involves an extra step but is usually better than straight-up taking the money from your eligible 401(k).

Which is Right for You?

As you can see, withdrawing from an IRA, because it has the built-in first-time homebuyer provision, is usually the best option, if you have an IRA available to you. But if you’re only working with an employer 401(k), you’ll need to talk to your employer about the possibilities.

Remember that you may need to talk to a financial planning professional about your options. In the long run, waiting to buy a home in favor of leaving your retirement funds intact could be a better option. It all depends on your current financial circumstances and your eventual financial goals.

Next Steps

IRS Resources

401(k) Withdrawal Rules

IRA Withdrawal Rules