You’ve been dreaming of owning a home, and you’ve found the perfect one in a great neighborhood. But you don’t have enough for a down payment.
You’re not alone: Coming up with money for upfront costs like down payments and closing costs is one of the biggest challenges for today’s homebuyers. For first-time homebuyers a typical down payment was 8% of the price of the home at the end of 2023, according to the National Association of Realtors data. And closing costs can range from 3% to 6% of the loan amount.
One option to cover a down payment is to make a withdrawal from a retirement account, like a 401(k) or IRA, or liquidate investments. After all, for many Americans, retirement accounts serve as both long-term savings and ongoing emergency funds. This may seem like a simple solution, but what does it mean for your long-term finances? Is it wise to dip into your retirement savings or investments to buy a home?
We’ll help you decide whether it’s the right choice for you, and also provide alternative ways to finance your down payment.
Key Takeaways
- Roth IRAs allow penalty-free withdrawals of contributions, and IRAs offer a $10,000 first-time homebuyer exception.
- Withdrawing from a 401(k) early comes with penalties and taxes, reducing your retirement savings.
- 401(k) plans let you “borrow from yourself,” but they come with repayment risks.
- Selling investments for a down payment can work, but be sure to consider market timing and taxes.
- Explore alternatives like low-down-payment mortgages and down-payment assistance programs.
Withdrawing From Your 401(k) for a Down Payment
If you’re short on a down payment but have a sizable 401(k), tapping it might seem like the easiest solution. “In some cases, tapping into your retirement savings could be a smart move,” says Jonathan Thomas, CFP, a private wealth advisor at LVW Advisors. “Especially if it helps you put down at least 20% and avoid private mortgage insurance (PMI). PMI can add a significant cost to your monthly mortgage payment, so eliminating it upfront could save you money in the long run.”
“That said,” Thomas continues, “if you’re considering using retirement savings, there are better options than your 401(k).” Consider the financial downsides of pulling from your 401(k) for a down payment.
Early Withdrawal Penalty
Most 401(k) plans penalize early withdrawals before age 59½. If you take money out early, you’ll likely face:
- A 10% IRS penalty on the amount withdrawn
- Income tax on the withdrawal, which could push you into a higher tax bracket
For example, if you withdraw $30,000, you could lose $3,000 in penalties and owe thousands more in taxes, depending on your tax bracket.
Some exceptions exist for hardship withdrawals, but buying a home doesn’t always qualify; it depends on the employer’s plan.
Diminishing Your Retirement Savings
Since retirement accounts grow over time thanks to compounding returns, early withdrawals reduce your current balance and eat into future growth.
For example, withdrawing $30,000 today from a 401(k) instead of letting it grow for 30 years at an average 7% return could cost you over $228,000 in lost retirement savings. That’s a significant hit to your retirement security.
Warning
Unless it’s an absolute necessity, withdrawing from a 401(k) early is rarely a good financial move. What else can you do?
3 Penalty-Free Ways to Use Retirement Accounts for a Down Payment
If using your retirement funds is your only option, the following strategies can help you avoid penalties:
1. Withdraw Roth IRA Contributions
You can withdraw the amount you’ve contributed to a Roth IRA at any point without penalties or taxes. However, you cannot withdraw earnings, i.e., the investment growth, without penalties before age 59½ unless you meet certain exceptions.
Since Roth IRAs are designed for tax-free growth, using them for a down payment now reduces their long-term benefit.
2. Withdraw Up to $10,000 of Earnings From an IRA for a First-Time Home Purchase
An individual retirement account (IRA) is a tax-advantaged account for your retirement savings. If you have a traditional or Roth IRA, you can withdraw up to $10,000 in earnings penalty-free for a first-time home purchase.
Keep in mind, taxes apply to traditional IRA withdrawals. And $10,000 may not cover a full down payment, especially in high-cost housing markets. Roth IRA earnings must be at least five years old for penalty-free withdrawal.
3. Take Out a 401(k) Loan
Some 401(k) plans let you borrow from yourself instead of withdrawing funds outright. Here’s how it works:
You can borrow up to 50% of your 401(k) balance up to a maximum of $50,000. As long as you repay the loan with interest, usually within 5 years (or longer if buying a primary residence), you won’t owe any withdrawal penalties or taxes.
However, taking the loan means you’ll miss out on future investment growth, which could stunt your long-term retirement plan progress. Also, some plans don’t allow contributions while you repay the loan, which could further slow your retirement savings.
Finally, if you leave the employer that sponsors your 401(k) account, “You will need to pay your loan in full,” says financial planner Saïd Israilov, CFP, of Israilov Financial. “Some plans allow you to pay on a monthly payment plan, but others might require you to pay off the entire loan balance immediately. If you can’t pay back the loan balance and you default, you could owe a 10% penalty on top of income taxes on the loan balance. Read your plan documents thoroughly, as repayment schedules and other loan requirements might vary.”
Using Other Investments for a Down Payment
Cashing out your money in stocks, bonds, or other investments is a better alternative to tapping your retirement funds. Looking at the downsides, you’d want to note market timing, taxes, and risk tolerance before you proceed. Consider the following:
- Selling losing investments in a down market locks in the losses due to market volatility.
- Investment profits are taxed at short-term (higher) or long-term (lower) capital gains rates depending on how long you hold the asset before selling it.
- If you plan to buy a home within three to five years, keep funds in low-risk options for easy access.
Lower-Risk Investment Options for Short-Term Savings
If you’re saving for a home, consider these less volatile investment vehicles:
If none of these options will work for you, there are other ways to fund your down payment without dipping into your retirement savings or investments.
Alternatives to Using Your Retirement Accounts or Investments for a Down Payment
Low and No-Down Payment Mortgage Options
- Veterans Affairs (VA) loans are available to veterans and require no down payment.
- U.S. Department of Agriculture (USDA) loans serve rural homebuyers and require no down payment.
- Federal Housing Administration (FHA) loans require as little as 3.5% as a down payment.
- Conventional loans offer options of 3% to 5% down for qualified buyers.
Other Sources of Cash for a Down Payment
Here are additional ways to get the funds you need for a down payment:
Gifted funds from family: Many lenders allow family gifts for down payments, but specific rules apply:
- The gift must come with a signed letter confirming it’s not a loan.
- For conventional loans, family gifts can cover the full down payment if they come from an immediate relative.
- FHA loans also allow family gifts but require documentation.
Down payment assistance programs (DPAs): Local, state, and federal programs offer grants or low-interest loans to help with down payments:
- Grants: These are free so you don’t have to repay them.
- Low-interest loans: Some DPA loans are forgivable if you meet certain conditions.
- Deferred loans: You don’t have to repay until you sell or refinance.
Side hustles or additional savings: Working to build up cash reserves over time helps prevent you from making any risky withdrawals.
What Is the Typical Down Payment for a House?
It varies, but first-time buyers often put between 8% and 13% down, while conventional loans typically require 5% to 20%.
At What Age Can You Withdraw From a 401(k) Without Penalty?
At age 59½ or older withdrawals are penalty-free.
Can I Withdraw From My 401(k) to Buy a Second Home?
Yes, but it’s not ideal. If you take money from your 401(k) before age 59½, you’ll likely owe a 10% penalty plus income taxes on the amount withdrawn. If your plan allows it and you take a 401(k) loan instead, you will avoid penalties, but you’ll need to repay the loan with interest, usually within five years.
Should I Prioritize Investing or Saving for a House?
It depends on your situation. If buying a home is a short-term goal (within the next few years), it’s better to save in low-risk accounts (like a money market fund or high-yield savings account) rather than investing in stocks, which can be volatile. If homeownership is a long-term goal, you can keep investing while gradually building up savings.
The Bottom Line
Withdrawing retirement savings or selling investments for a down payment is tempting, but it comes with trade-offs—like penalties, lost retirement savings growth, and tax consequences. Before you decide, consider low-down-payment mortgages, assistance programs, or saving in low-risk accounts.
If you do decide to withdraw, try to take out the lowest amount possible so you’re not jeopardizing your savings for the future.