Renting In A Hot Buyer's Market? Should You Use Retirement Funds As A Down Payment?

Although the subprime mortgage crisis that caused real estate prices around the country to plummet is less than a decade in the rearview mirror, housing prices have rebounded in many areas. If you find yourself in a housing market where prices seem to be rising exponentially, you may worry that you need to purchase now in order to preserve your ability to ever enter the world of homeownership. However, renting in these markets can be expensive, and saving up a down payment while prices continue to rise can be difficult. When should you consider using retirement funds for your down payment? Read on to learn more about the best types of retirement accounts to tap for a down payment, as well as some situations in which borrowing from your retirement funds may not be the best idea.

What types of retirement accounts are best for use as a down payment?

Because retirement funds are intended to support you when you no longer work for a living, most plans restrict withdrawals before a certain age -- usually 59 and a half. If your plan does let you withdraw funds early, they'll be subject to income tax and an additional 10 percent penalty. As a result, withdrawing funds from a 401(k) or similar workplace plan often isn't a good idea.

However, Roth individual retirement accounts (IRAs) consist of funds that have already been taxed. Although you can't withdraw earnings on this account early (except in a few specific situations), you are able to withdraw your Roth contributions at any time without paying taxes or penalties. This makes a Roth account a great savings option if you're planning to buy within the next few years, although you may want to invest it fairly conservatively to ensure that the deposit doesn't lose value before you can make a withdrawal of principal.

When should you avoid touching your retirement funds for a down payment?

In many cases, you may be able to qualify for a federally-backed mortgage that offers a low down payment or no down payment at all. This can help you enter the market in some high-priced areas without requiring you to spend years scraping together a down payment while paying high rent. Before withdrawing any funds from your retirement accounts -- even a Roth IRA -- you'll want to check into all your mortgage options to see whether you can get by without the typical 20 percent down payment. Contact a financial advisor for additional information.