Which Comes First: Saving for a House or Retirement

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If you have limited funds to regularly put towards your savings, deciding whether to save for a house first or contribute to retirement accounts will take some prioritizing. Both options have pros and cons that can depend on your situation.

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Starting With Retirement Savings

The investment management company Vanguard recommends prioritizing retirement savings over other goals due to the earnings potential that's highest when you start investing in your 20s. For example, given a ​4 percent​ annual inflation rate, ​$1​ invested at age ​20​ could be worth ​$5.84​ when you're 65. This is compared to ​$1​ worth just ​$3.25​ if you contribute it at age ​35​.

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If you put off your retirement contributions too long to save for a house instead, you'll end up needing to contribute much more to try to catch up. This can be harder on your budget and also be more difficult due to the yearly limits on retirement contributions per the IRS.

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It's also important to note that your retirement accounts are considered assets when you apply for a mortgage. While other information, like your credit score, assess creditworthiness, your assets minus your liabilities will give your lender a picture of your net worth. And while the money's designed to sit in your account until retirement, there's usually some flexibility to access these funds for a first home purchase.

Starting With First Home Savings

While prioritizing retirement savings helps you work toward a long-term goal, you might be in a situation where you want to start building equity and enjoy the perks of owning a home versus renting. In that case, putting off retirement savings to save for a down payment can still yield a return on investment as your property value increases. However, the return on investment from a down payment are generally lower than if you had put the same amount toward retirement.

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After you purchase the home, you'd then want to prioritize putting money into your retirement account and preferably maximizing the contributions allowed so you can try to catch up on the benefits lost by putting retirement savings on hold. You might want to check a retirement savings calculator to see how postponing contributions for buying a home will affect your retirement goals.

Considering Flexibility With Retirement Accounts

Although you can face income taxes and possibly an early withdrawal penalty, you can often take money out of retirement accounts like IRAs and 401(k)s early to buy a home. The rules vary by account type. Traditional IRAs offer flexibility with up to ​$10,000​ available without a penalty for first-time homebuyers, however you'll still have to pay income tax on the withdrawal. If you need more than this or you have a 401(k), you can expect to typically pay a ​10 percent​ tax penalty on top of income tax if you remove pretax contributions. A Roth IRA comes with the benefit of early withdrawals without penalties or taxes anytime when you've had the account ​five years​ or more.

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If you temporarily need some money for your down payment and will be able to put the money back into your account, then employers offering qualified plans like 401(k)s often allow you to take out a loan with interest. The amount is limited, based on how much of your retirement account is vested. You'll have to pay the loan back based on your plan's terms to avoid the loan getting classified as an early withdrawal instead.

Planning for Both Goals

While there are many benefits to start saving for retirement early, going that route doesn't have to mean you can't work toward buying your home. You might split your designated funds between retirement account contributions and your future home savings.

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Also, keep in mind the various options that make it easier to buy a home regardless of which route you take. You can first start comparing mortgage programs since down payments can be nothing for government programs like Veterans Affairs, U.S. Department of Agriculture and Federal Housing Administration mortgages and as little as ​3 to 5 percent​ for conventional programs. First-time buyers with financial need can often qualify for state assistance programs that offer money toward the down payment and possibly closing costs.

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