You're Mortgaging Your Future

Should I cash-in my IRA to buy my first home?

Struggling to raise money for a down payment is practically a rite of passage for first-time home buyers. And since tapping an IRA for the purchase of a first home is penalty-free for up to $10,000 per person, this move can sound like an easy way to access some much-needed dough. (Click here for a tutorial on the penalty-free ways to tap an IRA.)

But you're right to question the wisdom of this maneuver. To be sure, the benefits of homeownership are enticing-from the basic pride of being a homeowner to the ability to build equity and get a tax break on mortgage interest. And with mortgage rates so low these days, now may indeed be an excellent time to buy.

Draining retirement accounts to achieve this goal is costly, however. Think about it: The loss of tax-free compounding on $20,000 over 35 years translates into missing out on $297,707 (before taxes, assuming we're talking about a traditional IRA here), if the account grows 8% annually. Sure, it's hard to worry too much about retirement when it's still far off in the future, but trust us, the easiest way to guarantee a comfy retirement is to save aggressively when you're young.

Worse yet, once folks start tapping a retirement account for nonretirement reasons, they often find themselves on a slippery slope. "I've seen people go into the IRA for the so-called one-time reason," says Benjamin Tobias, a certified financial planner (CFP) and president of Florida-based Tobias Financial Advisors. But my impression is, once they go in, they feel like they've invaded it and can do it again. And retirement money never ends up being spent for retirement."

Keep in mind also that taking an early withdrawal — even for the non-penalty-triggering reasons — can also result in a big tax hit, particularly with a deductible IRA, in which every dollar will be subject to tax. (With a Roth IRA, only the earnings on withdrawals for first-time home buyers will be taxed, should the account be less than five-years old; if the account is older than that, withdrawals are tax-free.)

But there's a bigger issue here: If the only way for a couple to get into a home is to sacrifice IRA savings, then they probably aren't ready to buy that home in the first place. After all, scraping together the down payment is just the first step — houses cost a whole lot more than just that. Homes, after all, need to be filled with furniture. Then there's the ongoing repairs and maintenance. And don't forget homeowners insurance and property taxes. All of this (plus a whole lot more) can add up to a nightmarish bill each month, says Barbara Steinmetz, a CFP and licensed real-estate broker.

Our advice: Keep on saving, or consider a less-expensive home. Ideally, your annual mortgage payments, taxes and homeowners insurance shouldn't exceed 28% of your gross income, notes Steinmetz. Too see how much home you can afford, crunch your numbers in our calculator. If you're not there yet, then continue to save aggressively.