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For the average American, the answer is usually “no” since retirement accounts are a safety net in a world where most people don’t have enough money stored away. Retirement accounts represent a largely tax-free way that Americans can build wealth on auto-pilot, and have their money work for them without Uncle Sam taking half of it away. In most cases, Americans should only withdraw from their retirement accounts in truly desperate situations.
But are there exceptions? You betcha.
First-time homebuyers may have trouble qualifying for a mortgage without additional funds or collateral. If they have good cause to believe that they will be able to quickly repay the money into their retirement funds, borrowing here in order to secure their first piece of real estate may make sense. Later in life, it is generally easier for mortgage borrowers to qualify, between stronger income, more established credit and more assets (often including other real estate).
Another consideration is mortgage insurance, which is generally required when borrowers make a down payment of less than 20% of the purchase price. Mortgage insurance is not cheap, and can easily run $150/month for a $200,000 loan. Nor does it go away quickly; mortgage insurance usually must be paid for at least five years, and the onus is on the borrower to prove that the loan amount is lower than 80% of the current value of the collateral real estate. Mortgage insurance is lost money down the drain – it adds no value whatsoever to the borrower and only protects the bank. If you can tap into your retirement account to avoid paying mortgage insurance, it is often worth it.
Buyers with 401(k) accounts can borrow money from them relatively easily and cheaply, and for up to five years. There are some stipulations that 401(k) borrowers should understand however, that are outside the scope of this article, but in bear markets it can actually benefit 401(k) borrowers to pull money out temporarily.
For very short-term needs, IRA account holders can borrow penalty-free from their IRA accounts for up to 60 days at a time, and will not suffer any tax consequences. If you need an extra few thousand dollars in order to close your real estate investment deal, and are extremely confident that you can pay it back within a month, this can be a quick and easy way to bridge the gap.
But beware: if you fail to pay your IRA back within 60 days, the IRS will treat it like a distribution and will charge you income tax on that money, along with some potentially nasty penalties to boot.
Likewise, when a worker borrows against their 401(k) and then loses their job, they often must repay the borrowed money within a few weeks or face similar treatment from the IRS. That is a bad place to be – suddenly out of work and faced with immediately repaying borrowed money.
People considering tapping into their retirement accounts to buy real estate should also consider that real estate comes with unpredictable expenses. That gleaming home might have a furnace just waiting to start coughing smoke, or that rental property you’re eyeing up might need more repairs than you had expected, and stretching yourself too thin by pulling money from your retirement account might leave you in dire straits when an inevitable hiccup comes your way.
Retirement accounts should only be considered a viable option for financing your real estate purchase if you have other places you can turn if the unthinkable happens. Jobs can disappear overnight, homes can suddenly need $5,000 in unexpected repairs, tenants can skip out on rental properties without paying the rent. The world is full of surprises that can throw your finances in a tailspin, so be very careful when drawing on your retirement funds early, and be sure to have a backup plan for ugly contingencies.
Related Reading:
Can Real Estate Investors Use 401(k)s to Lower Their Taxes? Oh Yes
The 25X Rule for Retiring Early (…and How Rental Properties Change the Math)
The Hard Facts about Hard Money Lending
