Roughly 98 percent of people want to own a home, according to a recent Bank of the West survey. But coming up with the required funds can be tough — especially for cash-strapped millennials in today’s competitive market.
To finance their purchases, one in three millennial homeowners withdrew money from or took loans against their retirement accounts, according to Bank of the West’s survey of over 600 U.S. adults ages 21-34. Meanwhile, one in five millennials who are planning to buy a home expect to do the same.
It’s an “alarming” trend, according to Ryan Bailey, head of Bank of the West’s retail banking group. "Millennials are so eager to become homeowners that some may be inadvertently cutting off their nose to spite their face." He recommends relying on savings rather than dipping into your retirement funds.
“Borrowing from your retirement may make sense in special circumstances, but it’s definitely not a recommendation we tell people to do,” Bailey tells CNBC Make It.
What’s the problem?
If you don't have quite enough saved for your first home, you are allowed to pull money out of your retirement accounts, such as a 401(k) or an IRA. But while dipping into your retirement savings may help you put down a bigger down payment and lower your mortgage rate, it also may mean those savings could experience a long-term setback.
Think of it this way: You are not allowed to draw on your future Social Security payments to buy real estate and your grandparents weren't allowed to use their pensions, Colorado-based financial planner Kristin Sullivan tells CNBC Make It. "For millennials, the 401(k) is going to be the major component of their retirement. It is a sacred pact with your older self to take care of that older self," she says. If you can't afford to buy a house without raiding your retirement plan, she adds, you may not be able to afford to be a homeowner at this point.
Technically, you can withdraw the money from a Roth IRA if you’ve had one for at least five years: Those under 59 ½ years old can borrow up to $10,000 without penalty if you’re a first-time homebuyer, according to the IRS. And because you’ve already paid taxes on this money, you won’t have to worry about any additional fees.
If you’ve been contributing to your Roth IRA for less than five years, you can still pull out up to $10,000 — but you’ll have to pay income taxes on the amount.
If you have a 401(k), you’ll want to borrow the money as a loan, rather than taking it outright. Getting the money as a loan (up to 50 percent or $50,000, whichever is lower) helps you to avoid income taxes and a 10 percent early withdrawal penalty. But keep in mind that, as with any loan, you'll have to pay the money back, plus interest. Also, should you fail to pay back the loan on time, you may incur a 10 percent early withdrawal penalty.
Worse, the terms of the loan generally require that you keep your current job. If you want to switch or are let go for any reason, the full balance of the loan is typically due within 60 days. “This is even the case if you are fired from your job. You would have to pay back a loan at what may be the most inopportune time,” New York-based financial advisor Paul Tramontozzi tells CNBC Make It.
What are the alternatives?
Before using retirement savings to purchase a new home, review your current spending. Look for any expenses you can cut to save money.
"If someone is contemplating dipping into retirement savings, they likely they haven't been able to save up the required down payment to buy the house in the first place, which likely means they don't have a good handle on their finances to begin with," Illinois-based advisor Stephen Jordan tells CNBC Make It.
Millennials should also consider scaling down their home dreams in order to reduce the cost. Take a hard look at your finances so you don’t get in over your head, Danielle Hale, chief economist for Realtor.com, tells CNBC Make It. Just over 40 percent of millennial homeowners said in a recent survey said they had regrets after they purchased because they felt stretched financially.
“It takes being honest with yourself when you’re making a home purchase,” she says, adding that you should take advantage of filters on home search sites to make sure you're not shopping for something that's too expensive.
“With careful financial planning, millennials can have it all – the dream home today, without compromising their retirement security tomorrow,” Bailey says.