Has someone given your gift money to use for your down payment? Learn the ins and outs of gift funds and how they can be used to get your mortgage.
You’re ready to go house hunting, but you’re shy on a down payment. You do have some assets in the form of your investment retirement account, or IRA, but is it a good idea to withdraw IRA funds for a down payment on a home?
In This Article:
- IRA Account Basics
- Exceptions to IRA Rules
- Roth IRAs
- Self Directed IRAs
- Alternatives to Using Your IRA
IRA Account Basics
IRAs are designed to help you save for retirement, so the Internal Revenue Service (IRS) discourages people who want to withdraw any funds from them before they reach the age of 59½. To make it undesirable to withdraw early from an IRA, the IRS imposes a 10% penalty on the amount you withdraw, and also assesses income taxes on the withdrawn amount.
However, there are always exceptions to every rule, and that includes your IRA. Under certain circumstances, you can withdraw an amount from your IRA earlier without the penalty. Some of these exceptions relate directly to home buying.
Exceptions to IRA Rules
First-time home buyers (FTHBs) can take advantage of an IRA withdrawal exemption to access up to $10,000 each once in your lifetime. It’s worth noting that first-time in regard to IRA withdrawals is different from the real estate industry’s definition.
To qualify for the IRA exemption, neither you or your spouse can have owned a principal residence in the past two years. You can have owned a home in the more distance past, and you can still own a timeshare or vacation or second home.
You don’t even have to be the person shopping for a home. If your parent, child, or grandchild is home shopping and they meet the above criterion, you can take the money out to use for their home purchase.
If you and your spouse each access $10,000, you’ll have $20,000 to put towards the down payment on your new home. If you don’t have that much in your IRA accounts, there are some other options you can explore.
Roth IRAs are different. You can withdraw money up to the amount you’ve already contributed both penalty and tax-free, since you’ve already paid tax on your contributions.
You can withdraw an additional $10,000 for a first-time home purchase without paying the penalty, but will have to pay income tax on that amount. However, this doesn’t apply to funds converted from another account, and it also doesn’t apply if your Roth is older than five years.
Self-directed IRAs, or SDIRAs, give you a lot more control over your money. Since you can invest your SIDRA in a wider variety of investments, including real estate, you can “invest” in a house. The catch here is that you can’t live in a house bought with SIDRA money, and neither can any relative.
SIDRA purchases must be at arm’s length, so you’ll only want to use this option if you’re buying a house as an investment and plan to rent it out. Once you reach the age of 59½, and can legally withdraw assets from your SDIRA, the home can become part of your distribution and you can live in it starting then.
Alternatives to Using Your IRA
The main drawback to using your IRA to fund part of your home purchase is that you can’t replenish IRAs. You can invest only six or seven thousand a year depending on your age, and once you withdraw it, that easy compounding interest is gone forever.
Some people open up IRAs specifically to store funds for a downpayment on a home. However, if that was never your intent, you might be better served by using funds from another source, like a 401(k) or private mortgage insurance (PMI) to handle your down payment.
You can typically take a loan from your 401K account equal to or less than 50% of the balance or $50,000, whichever is less. You won’t incur taxes or penalties. The interest rate for a 401(k) loan is typically also only prime rate plus one or two interest points.
Most 401(k) loans have to be repaid within five years, but if you’re using the money to buy a home, you may be able to stretch that to 15 years. However, if you ever miss payments, then after 90 days the balance of the loan will be taxed as a distribution from your 401(k) and you’ll pay the 10% penalty if you’re younger than 59½.
If you lose or leave your job while you’re repaying your 401(k) loan, you’ll have to suddenly repay the entire balance in 60-90 days, or it will be considered a distribution and taxed, and penalized just like an IRA.
Private mortgage insurance (PMI)
Some home loans will allow you to provide a much smaller down payment if you purchase private mortgage insurance (PMI). This means you’ll have to pay every month for the life of the loan or until the loan to value (LTV) on your loan reaches a certain balance.
PMI is a good alternative to using IRA or 401(k) funds to make your down payment. It can help prevent you from tapping out your retirement accounts, and you can usually refinance your way out of PMI some years into your mortgage.
If you’re considering taking a big chunk out of your IRA to pay the down payment on a house, think twice. You’ll be severely damaging the earning potential of your retirement accounts. You might want to reconsider whether it’s the right time to be shopping for a home, or look into programs that can reduce your down payment.
If you think an IRA is a good way to save money for a down payment, consider opening an IRA account specifically for that purpose and making sure you’ll qualify as a first-time homebuyer when the time comes. Then you won’t be taking money meant to be earning until your retirement out of play.
Why Choose Sammamish Mortgage?
At Sammamish, we understand how overwhelming the home buying process can be. We’re committed to helping you navigate the process, from preapproval for your loan to helping you figure out how to manage your down payment. Our experienced loan officers will help you find the home loan product that is best for you.
Sammamish Mortgage has been in business since 1992, and has assisted many home buyers in the Pacific Northwest. If you are looking for mortgage financing in Washington State, we can help. Sammamish Mortgage offers mortgage programs in Colorado, Idaho, Oregon and Washington.
Contact us if you have any mortgage-related questions or concerns. If you are ready to move forward, you can view rates, obtain a customized instant rate quote, or apply instantly directly from our website.