Should I use an IRA for a down payment?

Q: What are the pros and cons of taking money out of an IRA to use as a down payment on a home?

A: If you are a first-time home buyer, you can take up to $10,000 out of an IRA without incurring the usual 10 percent tax penalty for early distributions. However, if it is a traditional IRA, you would still have to pay inome tax on the amount you take out of the IRA for this purpose; if it is a Roth IRA, you should already have paid income taxes on the money.

Assuming you qualify for that $10,000 exception, the following should be how you prioritize where money for a down payment comes from:

1. First, draw from non-retirement savings, since this is already after-tax money which is not receiving any ongoing tax advantages.

2. Second, draw up to the $10,000 exception limit from a Roth IRA if available, because while you will incur no new taxes on this money. However, you will lose the tax benefit of having the money in an IRA.

3. Third, draw from a traditional IRA if necessary, but only up to the $10,000 exception limit. A traditional IRA is the last choice because you both have to pay taxes upon withdrawing the money, and then lose the ongoing tax benefit of having money in an IRA.

A mortgage calculator can help you understand the benefit of adding to a down payment with a withdrawal from an IRA. A mortgage payment calculator will show you how increasing your down payment can either lower your monthly payment or increase the amount you can spend on a house at the same payment level. An amortization calculator can show you how a larger down payment will reduce the amount of interest you pay over the life of the loan.

Once you've calculated those benefits, you will be able to weigh them against the tax consequences of taking money out of an IRA.

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