Tapping Your IRA to Buy a Home? You May Want to Rethink That.

Many people dream of owning a home. But these days, that dream has become pretty tricky to bring to life.

Not only have mortgage rates been elevated these past few years, but home prices are up on a national scale. That double whammy has been especially discouraging for younger buyers, many of whom don't have thousands upon thousands of dollars on hand to put toward a down payment.

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If you've been struggling to buy a home but have money in an IRA for retirement, you may be thinking of taking an early withdrawal to come up with your down payment. Normally, when you tap a retirement account before age 59 1/2, you face a 10% early withdrawal penalty on the sum you remove. But there are some exceptions.

If you have an IRA, you're allowed to withdraw $10,000 at any age to buy a first-time home. And it's an option you may be considering if you don't see another path toward that down payment. But tempting as it may be to raid your IRA to buy a home, it's a move you might sorely regret in the end.

The danger of taking an early IRA withdrawal

Withdrawing $10,000 from your IRA to buy a home might seem like a low-risk proposition. For one thing, you're buying an asset that could potentially gain value over time. And also, you could conceivably ramp up your IRA contributions later in life -- perhaps once your income rises -- to make up for that withdrawal.

The problem, though, is that any funds you remove from your IRA ahead of retirement are funds you won't have on hand during retirement. Worse yet, any money you take out of your IRA is money you can no longer invest. And there lies the real danger.

Let's imagine your IRA normally generates a yearly 8% return, which is a bit below the stock market's average. If you remove $10,000 at age 35 to buy a home and retire at 65, which is when Medicare eligibility begins, it means you'll have lost on 30 years of compounded returns. It also means you're looking at retiring with roughly $100,000 less than what you could've had if you'd left that $10,000 in your IRA earning 8% a year.

Keep in mind that once you retire, Social Security will only replace a small portion of your former paycheck. So it's helpful to have as large a nest egg as possible. If you take an IRA withdrawal ahead of retirement, you risk falling short when you need that money the most.

Other paths toward buying a home

You may feel like the only way you can afford a home down payment is to tap your IRA early, especially given how high home prices are today in most U.S. markets. But there may be other avenues you can explore that don't have you taking an IRA withdrawal when that money is supposed to earmarked for your retirement.

One option could be to see if you qualify for a down payment assistance program through your state. Another is to see if you qualify for a low or no down payment mortgage. VA loans, for example, allow eligible borrowers to buy a home with no down payment. And FHA loans come with low down payment requirements.

This isn't to say that taking an IRA withdrawal to buy a home is always a bad idea. But before you do it, make sure you understand the potential drawbacks involved. You may be better off waiting a few more years to buy a home than potentially sacrificing your financial security later in life.

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