Can You Get a Loan Against Your IRA for a Home Purchase? What to Know

Buying a home is an exciting milestone, but coming up with the down payment can be challenging. If you have money saved in an individual retirement account (IRA), you may be tempted to tap into those funds. But is taking out a loan against your IRA a smart move for financing a home purchase?

There are a few ways to access money in an IRA account, and each has pros and cons As you weigh your options, here are some key factors to consider before moving forward with an IRA loan for buying a house.

What is an IRA?

An IRA is a type of tax-advantaged retirement account that helps individuals save money for the future. There are a few different types of IRAs:

• Traditional IRA – Contributions are often tax-deductible and funds grow tax-deferred. Withdrawals in retirement are taxed as ordinary income

• Roth IRA – Contributions are made with after-tax dollars. Funds grow tax-free and qualified withdrawals in retirement are tax-free.

• SEP IRA – A special type of IRA for self-employed individuals and small business owners.

• SIMPLE IRA – An IRA associated with a SIMPLE IRA retirement plan offered by small employers.

No matter the type, the primary purpose of an IRA is to save for retirement. The government provides tax incentives to encourage this. As a result, there are rules and restrictions around accessing IRA funds prior to retirement age.

Can You Take Out a Loan Against an IRA?

Yes, it is possible to take out a loan against your IRA funds. This is called an IRA home loan, IRA mortgage, or IRA collateral loan.

Here’s how it works:

• You use your IRA balance as collateral for a loan from a lender or IRA custodian.

• Interest rates may be slightly higher than a traditional mortgage.

• You don’t have to take distributions or pay taxes and penalties for early withdrawals.

• You make payments back into your IRA account, plus interest.

• If you default on the loan, your IRA could be surrendered to repay the balance.

While IRAs weren’t designed for this purpose, the IRS does allow you to borrow against your account value without tax penalties. Just be aware that not all IRA providers offer this type of loan.

Pros and Cons of an IRA Loan for Home Purchase

Taking out an IRA loan for a down payment might seem convenient, but it’s not ideal for everyone. Consider the potential pros and cons:

Pros

• Access funds without taxes or penalties
• May help you buy sooner than otherwise possible
• Interest repaid goes back into your IRA

Cons

• Risk of losing retirement savings if you default
• Less money growing for retirement
• May not be allowed by all IRA custodians
• Higher interest rate than traditional mortgage
• Short repayment term of 5 years or less

As you can see, an IRA loan involves tapping into money earmarked for your future retirement. While it comes with fewer penalties compared to early IRA withdrawals, it still carries risks.

Alternatives for Home Down Payment Funds

Here are some other options for funding a home purchase without using retirement savings:

• Save in a separate account – Open a dedicated high-yield savings account and direct a portion of each paycheck into it.

• Reduce expenses – Try cutting back discretionary spending to ramp up savings rate.

• Down payment assistance – Look into grants, loans and programs targeted at first-time homebuyers.

• Family gifts – Ask for help from relatives who may gift you cash.

• Low down payment loan – Explore FHA or VA loans that only require 3.5% down.

• Sell assets – Cash out non-retirement investments or other assets that have appreciated.

• Home equity line of credit – Current homeowners can tap home equity rather than retirement funds.

The more money you can save outside of your IRA, the less you’ll have to touch it for the home purchase.

Rules for IRA Withdrawals to Buy a Home

If you decide an IRA loan isn’t right for you, a direct IRA withdrawal is another option. Here are some key rules to know if taking this route:

• Applies to traditional and Roth IRAs
• Limited to $10,000 lifetime withdrawal
• For first-time home buyers only
• Funds must be used within 120 days
• Income taxes apply, but no early withdrawal penalty

Qualified first-time home buyers are exempt from the 10% penalty tax on IRA withdrawals up to $10,000. However, regular income taxes will still apply on the distributed amount.

And you only get one shot at this exception — if you withdraw $10,000 to buy your first home, you can’t tap IRA funds again later for a second home purchase.

Using a 401(k) Instead of IRA for Down Payment

If you have an employer-sponsored 401(k) plan, you may have more flexibility than with an IRA. Some things to know:

• You can borrow up to 50% of your 401(k) balance or $50,000.
• Loans aren’t taxed if paid back based on plan terms.
• Payments are made back into your account with interest.
• If you leave your job, the balance is usually due immediately.
• Failure to repay can result in taxes and penalties.

The right loan option depends on your specific circumstances. Generally, a 401(k) loan will be better than an IRA loan or withdrawal. But ideally, you should avoid using any retirement funds.

Talk to a Professional First

With something as important as buying a home and securing financing, it pays to speak with the experts first. Here are some professionals who can help guide your decisions:

• Financial advisor – Get input on the best sources to tap without compromising retirement.

• Tax professional – Understand the tax implications of any IRA transactions.

• Banker or mortgage lender – Explore specialized mortgage products and assistance programs.

• Real estate agent – Get perspective on timing, costs, and the local housing market.

Don’t go it alone when making major financial choices. The right professionals can provide valuable assistance in weighing the alternatives and finding the optimal path forward.

The Bottom Line

While it is possible to leverage your IRA funds for a home purchase through a loan or withdrawal, proceed with extreme caution. Try to exhaust all other options first, as dipping into retirement savings comes with risks. Seek guidance from financial and tax advisors to make an informed decision based on your unique situation.

With the right preparation and perspective, you can hopefully reach your homeownership goals without compromising your long-term financial security. Do your homework and weigh all the factors carefully as you chart the road ahead.