A first-time homebuyer can be someone who's never owned residential property before, or it can be someone who has only previously owned property under some narrow circumstances. These homebuyers enjoy favor with the IRS in two respects. First-time homebuyers (FTHBs) can qualify for penalty-free IRA distributions and Federal Housing Authority (FHA) loans.
The exact definition of a first-time homebuyer varies depending on which government-offered provision you want to take advantage of. Different rules apply.
What Is a First-Time Homebuyer?
For purposes of securing a lower-interest-rate FHA mortgage, the basic definition of an FTHB is someone who hasn't owned a home in the past three years. According to the Department of Housing and Urban Development, which oversees the FHA, you might also be considered a first-time home buyer if you are:
- A single parent who has owned a home only with a former spouse while you were married
- A displaced homemaker who has owned a home only with a spouse
- An individual who has only owned a principal residence that wasn't permanently affixed to a permanent foundation in accordance with applicable regulations
- An individual who has only owned a property that was not in compliance with state, local, or model building codes and that can't be brought into compliance for less than the cost of constructing a permanent structure
You or your spouse can't have owned a home for two years prior to purchasing the home you're now acquiring if you're looking to take an early IRA distribution without penalty. The "date of acquisition" is defined as the date you sign a contract to buy the property, or the date on which construction or reconstruction of a home begins.
You're a first-time homebuyer if you had "no present interest in a main home during the two-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild," according to the IRS.
Your spouse must also meet this no-ownership requirement if you're married.
- Acronym: FTHB
How Early IRA Withdrawals Work
Normally, you can't withdraw money from a traditional IRA before age 59½ without paying a 10% tax penalty. But you can do so to purchase or build a home if you're an FTHB. In addition to buying, building, or rebuilding a home, you can use the IRA distribution to cover settlement, financing, or other closing costs before the close of the 120th day after the day you took the withdrawal.
Keep in mind that you'll still have to pay your regular income tax rate on the distribution even though you won't have to pay the early withdrawal penalty on the amount you take out of your IRA.
You're permitted to spend the money from an early withdrawal on the main home of an FTHB other than yourself. That person could be your spouse, your child or grandchild, your spouse's child or grandchild, your parent or other ancestor, or your spouse's parent or ancestor.
The maximum amount you can withdraw for all FTHB distributions over the course of your lifetime is $10,000. Your spouse can withdraw a total of $10,000 as well if you're married.
You can withdraw the total amount of money you've contributed to a Roth IRA prior to age 59½ without paying a tax penalty because you funded it with after-tax dollars. There's no $10,000 limit on those distributions, but you'll have to pay the 10% penalty on greater distribution amounts if you want to withdraw more than what you've invested in a Roth. You'd be withdrawing gains from your invested amounts.
How FHA Loan Benefits Work
The FHA doesn't issue loans. They're obtained through banks and lenders, but the FHA effectively insures them.
You can put down as little as 3.5% of the purchase price of the home as a down payment if you have a credit score of 580 or better. You'll have to put 10% down if your credit score falls between 500 and 579, but most banks won't be willing to lend to you if your credit score is less than 580.
Someone—a family member or close friend—is allowed to give you the amount of your down payment as a gift if you don't have it yourself. You just can't be required to ever pay it back.
There are many state-administered FHA programs that assist homebuyers with down payments, and individual counties determine the maximum and minimum amounts you can borrow through an FHA mortgage.
Borrowers who obtain FHA loans are required to purchase mortgage insurance, which typically costs from 0.80% to 1.05% of the value of the loan amount annually. And all first-time homebuyers who seek federal assistance through any program must attend a HUD-approved House Counseling class.
- Qualifying first-time homebuyers can take early withdrawals from their IRAs without incurring the usual 10% penalty.
- They can also qualify for special low-rate FHA mortgages.
- Defining rules for first-time homebuyers can vary between these two programs, but this doesn’t have to be your very first home purchase.
- You can’t have owned a home for at least the last two years, but some extenuating circumstances are provided for qualifying for FHA loans.