Should You Raid Your IRA Early to Avoid Foreclosure?

This post may contain affiliate links which may compensate us based on your interaction. Please read the disclosures for more information.

Foreclosure could destroy your credit, not to mention leave you without a home. But should you withdraw from retirement savings to avoid it? 

Many people buy homes with every intention of repaying their mortgages. But sometimes, things happen.

If you lose your job or get hit with a string of unplanned bills, you might land in a situation where you struggle to keep up with your housing payments. And if you miss too many payments, you could land in foreclosure.

The problem with foreclosure is twofold. First, if a lender forecloses on your home, it means you no longer have a home to live in.

A foreclosure could also cause major damage to your credit score. And since a foreclosure will stay on your credit report for seven years, it means you might struggle for a long time to do everything from getting approved for a credit card to securing a rental.

Now, if you truly have no funds to use to pay your mortgage, foreclosure may be inevitable. But what if you have a modest balance in your IRA — enough money to get current on your housing payments and tide yourself over until your financial situation improves?

You may be tempted to tap your IRA to avoid foreclosure. But should you?

You’ll risk a massive penalty

IRAs offer tax breaks because the IRS wants to encourage workers to save for retirement. So if you put money into a traditional IRA, the IRS won’t tax you on those contributions.

In exchange, the IRS wants that money to stay where it is until you reach retirement age. If you take a withdrawal before age 59 1/2, you’ll risk a 10% penalty on the sum you remove. A $25,000 withdrawal, for example, will result in a $2,500 penalty.

Plus, IRA withdrawals are taxed, so you’ll lose a chunk of what you remove to the IRS regardless. This isn’t a penalty — the same taxes would apply in retirement. But it’s a negative consequence nonetheless.

You’ll risk falling short on funds in retirement

The more money you remove from your IRA ahead of retirement, the greater your risk of not having enough money to live on during retirement. Remember, too, that when you raid your IRA, you don’t just lose out on the principal sum you remove. You also lose out on potential growth.

If your IRA is invested at an average annual 10% return, which is in line with the stock market’s long-term average, then removing $25,000 to avoid foreclosure won’t just mean ending up $25,000 short in retirement. Rather, it will mean having almost $170,000 less if retirement is 20 years away.

Alternatives to raiding your IRA

Taking funds from an IRA ahead of retirement could have really unfortunate consequences. So can foreclosure. It’s hard to say whether you should raid your IRA to avoid foreclosure or not.

But what is certain is that it pays to take some steps before reaching that point. One step is to contact your lender and discuss a short sale.

In a short sale, your lender accepts a certain price for your home and writes off the remainder of your mortgage balance. If your home is only worth $250,000 and you owe $320,000 on your mortgage, your lender would write off the $70,000 difference.

A short sale, too, will remain on your credit report for seven years. But a short sale isn’t considered to be as unfavorable as a foreclosure, so the damage may not be as severe.

You can also try to look at ways to monetize your home so you can stay in it. Renting out portions of your living space might work to drum up the cash you need, so if you have a finished basement or garage, that’s worth considering. You can even rent out a parking space in your driveway if there’s demand for it.

You may decide to raid your IRA to avoid foreclosure and stay in your home. If you feel that your current financial situation is temporary and likely to improve, then the hit to your IRA may be worth it — even with the penalty involved. That way, you can stay put and avoid years of credit score damage.

But think carefully before tapping an IRA ahead of retirement. Doing so could put you in an even worse situation than a mid-life foreclosure.

Our best stock brokers

We pored over the data and user reviews to find the select rare picks that landed a spot on our list of the best stock brokers. Some of these best-in-class picks pack in valuable perks, including $0 stock and ETF commissions. Get started and review our best stock brokers.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

 Read More