Can You Fall Back on Your IRA for a Down Payment on a Home?

These days, many first-time home buyers are struggling to break into the real estate market. We can thank higher mortgage rates and home prices for that.

If you're eager to buy a home but are short on down payment funds, you may be thinking of tapping your IRA. Normally, taking an IRA withdrawal prior to age 59 1/2 means facing a 10% early withdrawal penalty. That's clearly not something you want. However, there's an exception for first-time home buyers.

If you fall into that category, you're allowed to take a penalty-free IRA withdrawal of up to $10,000 to purchase a first-time home. And if you're married to someone with an IRA in the same boat, that $10,000 limit applies to each of you individually. So, collectively, you'd be able to withdraw a total of $20,000 from your IRAs penalty-free to fund a home purchase.

You may be tempted to fall back on your IRA for a home down payment. But here's why that's not such a great idea.

You may not get very far

In March, the median sale price for an existing home was $375,700, according to the National Association of Realtors. Now it's a good idea to make a 20% down payment on a home to avoid private mortgage insurance, a costly premium that makes your housing costs rise. But mortgage lenders will commonly accept a 10% down payment.

But let's say you're aiming for 20% down. For a home priced at $375,700, you'll need around $75,000. For a 10% down payment, you'll need about $37,500. Tapping your IRA for $10,000 won't get you to where you need to be. The same holds true even if you're married and you and your spouse can each withdraw $10,000 from an IRA for home buying purposes.

You might end up short on retirement funds

The main purpose of funding an IRA is to have money available for retirement. It's not to buy a home. If you take a withdrawal from your IRA for something having nothing to do with retirement, you'll risk ending up short on funds when your senior years actually roll around.

Now, you may be thinking, "What's the big deal if I wind up with $10,000 less in savings?" But remember, when you take an early IRA withdrawal, you don't just lose out on that principal sum. You also lose out on growth.

So, let's say your IRA is heavily invested in stocks and therefore generates an average annual 8% return, which is a bit below the stock market's average, as measured by the S&P 500 index. If you remove $10,000 from your IRA at age 35 to buy a home and you don't retire until 65, that $10,000 withdrawal will end up costing you about $100,000 in retirement savings. That's a much bigger deal.

All told, it's easy to see why you might look to turn to your IRA when you need money to buy a home. But a much better bet is to leave your long-term savings alone and find another way to come up with the funds you need for a down payment.