How to Use Home Equity, 401(k)s, or IRAs to Invest in Real Estate

David:
This is the BiggerPockets Podcast show 881. What’s going on, everyone? This is David Greene, your host of the BiggerPockets Real Estate Podcast. Here with Rob Abasolo hanging out today. Robbie, how are you?

Rob:
I’m good, man. I’m good. I think I just negotiated a really good real estate deal. The seller was very flexible and I’m excited. I love closing deals, man. I love it.

David:
Yeah. Rob practices the yoga method of real estate investing. He’s always looking for flexible sellers.

Rob:
Well, we won’t be talking about the yoga method today, but we are going to be talking about some really great concepts for leveraging the wealth that you’ve already built in today’s episode. I know a lot of you at home have been wondering, can you use a 401(k) to buy a house? Can you use a HELOC or should you use a HELOC? Should you do a cash-out refi? Can you use a Roth IRA to buy more rental properties? And are there tools out there that you can use to keep leveraging the wealth that you’ve already built? We’re going to be talking about this and so much more in today’s episode.

David:
That’s right, Rob. We’re going to be covering that and more in today’s show with Kyle Mast, a certified financial planner who is also a frequent contributor on the BiggerPockets Money Podcast. And let’s get to Kyle.
Kyle Mast, welcome to the show. Thanks for coming on today. All right, let’s kick this off. What is your definition of equity for our audience?

Kyle:
That’s a good question. Let’s keep it real simple, real quick. The market value of your house minus any debt you’ve got on your house, so that’d be your mortgage. So if your house is $500,000 in value, mortgage is $300,000, your equity is 200. You can get a little more complicated than that. A lot of people want to say, “I have a whole lot of equity in my house,” but it’s hard to get to it sometimes. So just a quick example,.if you sell the house, you’re going to lose 25 grand in commissions and some other sales costs. So now, your 200,000 in equity goes down to really 175. So if you’re thinking of equity that you can access, that’s maybe a better way to think of it. But to keep it simple, it’s the difference between the value of the house minus the debt you’ve got on it. It’s what you own.

David:
Very nice. Rob, anything you want to add to that?

Rob:
I think that’s honestly, most people, it’s kind of funny how they don’t really know this particular concept because a lot of people actually have a higher net worth than they think, and it’s all oftentimes in the equity of their house. They don’t really understand that that is a contributing factor to how much money they can retire with when they sell those properties. But a lot of times, just like you said, Kyle, no one ever thinks about the closing costs, which really do sneak up on you, especially the higher your property ends up being valued at.

David:
All right, so the most popular way that Americans access their equity is through a cash-out refinance. Can you explain what that is and how it works?

Kyle:
This is an interesting concept, and I like how you said the most popular way is the cash-out refinance, and that’s up for grabs now these days but we’ll get to that in just a bit here. The cash-out refinance is essentially if you have a house that you bought and it’s gone up in value and your loan has slowly gone down in value as you pay it down over time, you end up having more of that equity in your house. So a lot of times, people want to access that equity. And if you can think of, bad example, but back in the recession, maybe prior when people were running up some stuff on credit cards but their houses were growing like crazy, you just do a cash-out refinance, put a bigger loan on your property, pull out some of the cash that was equity, you pull it out as cash, pay off your credit cards, rinse and repeat, do it again. That’s a bad example of what to do with the cash-out refinance equity.
But essentially when you do it, you put a new loan on your property, you get rid of the old loan. And usually the new loan is bigger so that you have cash that you can access and you have to have a property that’s going to qualify for that. So essentially, you’ve got enough equity there that the bank is okay lending you more for that cash-out refinance above the current mortgage that you have on the property. Although you can actually do it without a mortgage on your property, you can just stick one on there if it’s a completely owned property. But usually, the cash-out refinance means that you have the loan there.

Rob:
Yeah. So this is obviously a big option for Americans, and I’ve heard that the amount of equity collectively in America is a pretty staggering number. Do you happen to have that stat handy or do you know it off the top of your head?

Kyle:
Off the top of my head, but in the show notes that we have for this show. So I’m not going to say that I am on this all the time, but it’s like around $30 trillion of equity that people are sitting on, and there’s a lot of reasons for that. There’s really low mortgage rates that have been for quite a while. People have been sitting on homes for a lot longer than they have in the past, and the refinance boom has really tapered off in the last couple of years because of the interest rates going up. So people are now re-stretching loans bigger onto their properties. That equity is continuing to grow and people don’t want to lose the low interest rate that they have locked in on their original mortgage on their property. So those are some of the reasons that it is really huge historically, that we have this amount of equity that people are just sitting on.
Another reason for it too is just the government printed a lot of money in the last few years and everything inflates and including the equity in your house, one of the reasons to own real estate.

David:
Now, people don’t like the cash-out refi option when they’re going from a lower rate to a higher rate, and that means that people won’t use that even though it is the most popular way, like we mentioned. So a lot of people have turned to HELOCs instead. Can you explain what a HELOC is?

Kyle:
Like you just said, that cash-out refinance has gotten a lot less appealing when someone has a 3.1% and they say, “Well, I’d like to pull $100,000 out and use it for something, but I got to get rid of my just stellar 3% loan and go to a 6.5, 6.75, 7 plus percent loan doubling my interest rate.” It just doesn’t make a whole lot of sense. And honestly, in the past when I had a financial planning firm, I would tell clients, “If your loan that you have is less than the historic rate of inflation, if the interest rate on your loan is less than the historic rate of inflation, you should really think of that loan as an asset because over the long run, the lending institution is actually paying you to borrow money from them.
It’s a weird concept to think about, but as money inflates, they’re losing money on that loan every year.” So these loans that people have that are, we don’t have the percentage in the show notes which is a bummer because I don’t have it off the top of my head, but that percentage of people that have an interest rate between 3 and 4% is huge right now. So they don’t want to get rid of those. They want to leave those on their property.
The home equity line of credit is essentially a line of credit, like a credit card, but it’s secured by the property. So you can get a home equity line of credit in addition to your first mortgage that is on your property, and it can be all kinds of different amounts. It’s usually a variable rate, but for an example, if you have a $500,000 property that you owe $300,000 on as a first primary mortgage, so you got a 3% awesome mortgage on that, but you want to borrow some more or cash-out refinance but you don’t want to get rid of that, you could do a HELOC, a home equity line of credit, where a second lender will come in second position and put a HELOC on that property maybe for 100,000. So now you’ve got access to another 100,000. And just something to keep in mind that people a lot of times don’t know, but you don’t pay interest or payments on a HELOC unless you use it.
A lot of people will be like, “Oh, I don’t want to get one because I don’t want to have to pay another payment on 100,000 of lending.” And I’ll often tell people, “If you got the equity, go get one in place. It costs 100 bucks a year administrative fee at your local credit union to have a HELOC on a property that you’ve got equity in. You don’t have to use it. The interest rate could be 30%. It’s not. They’re usually around the 10% range these days, but if you’re not using it, you’re not paying any interest but you have it there as a fallback, as an emergency. Why not have it? It’s a pretty low cost to have it for a 50 to $100 administrative fee a year that you’re paying to the second institution to have it in place in case something comes up, whether it’s an opportunity for investing or an emergency with your family. Whatever it is, it’s just a really nice big credit card to have in the back of your pocket.”

Rob:
I love it. Yeah, I love HELOCs for that exact reason. It’s very different from, I don’t know, some other types of loans where like a refi for example, whatever amount of equity that you choose to draw in a cash-out refi, you’re paying interest on it. They don’t extend it to you like a line of credit. Whereas a HELOC, I have a HELOC on one of my first properties that I ever bought. I want to say it’s like $120,000, which is great, obviously. I’ve never reapplied to get it higher, but it’s really nice to know that I have equity in my house that I can use to buy more real estate or to do any kind of renovation projects. I actually used my HELOC one time to go out and do a new construction and built most of that cash and refi and then paid back the HELOC.
So there are a lot of really, really great strategies that you can implement when using a HELOC, but how do you get one? More on that plus some HELOC pitfalls to look out for and how you can leverage your 401(k) to invest in real estate after the break.

David:
And welcome back. We’re here with certified financial planner, Kyle Mast, and he’s breaking down the ways that you can access equity to fuel your real estate investments. So far we’ve covered the cash-out refi and now we’re jumping back into HELOCs.

Rob:
My question to you, Kyle, is how hard is it to get a HELOC? Because I’d imagine there’s still a bit of an underwriting process there, much like there is with the cash-out refi.

Kyle:
Yeah, it is. And just before we go too far from what you were saying, Rob, those are some really good examples of good uses of a HELOC. They can be used really well in short-term opportunities. That’s really the best place to do it because of the variable rate that’s on them and because of that piece that you touched on, which was so good, is you can use as much as you want. You can use the 100,000 that you have or you can use 10,000, pay it off. You can use another 10 next year. You can use 30 here. You don’t have to pull it all out and pay interest on all of it all at once.
But yeah, as far as qualifying for one or underwriting for one, it’s very similar to a home primary residence mortgage. You’re going to have to look and see what the bank requires for your income. They’re going to look at the ratio of the debt that you have on your cars, on your house, everything in a personal qualification standpoint. There are some products out there. There’s not a lot of them that you can get from different non-traditional lenders that will lend a line of credit on rental properties. Actually, maybe five or six years ago, we got just a straight rental property line of credit from a local credit union. It was a great product. It was pretty cheap. That one was based on personal income underwriting.
But I know there are some lenders out there, and David you could speak to this too, that will lend on even a portfolio of real estate. So if you have maybe five properties that have a decent amount of equity within them, sometimes they’ll do a line of credit that is based on a portfolio of real estate or a piece of real estate. But when you’re more of an enterprise as a real estate investor and you can show that and prove that, have you run into those products, David?

David:
We offer them on investment properties now. It used to be super hard to get those. I would, man, this was probably six, eight years ago, I would go Google every single credit union in a city and just call them all and say, “Can you do a HELOC on investment property?” and make my way down this list. Now, we have lenders that we know that one of our guys can just shoot an email to all of them and say, “Who’s doing investment property HELOCs?” And they’ll come back and they’ll give you the terms like X amount above prime and what the loan to values are. So they’re much easier to get, but they’re also more expensive, significantly more expensive than on primary, and that will shock people a lot of the time.

Kyle:
Yeah, definitely. And I should say too, on the primary and also on the rental properties too. As you go up in percentage of LTV that you’re getting your HELOC for, it’s going to cost more. So to say that a different way, if you have a mortgage that is 60% of the value of your property and you get a HELOC that just brings up your total loan to value ratio from 60 to 70%, the interest rate’s going to be higher than your primary mortgage. But it’s not going to be terrible. But there are products out there. You can go to 80% or 90% LTV sometimes, but you will get hit with a really high interest rate when you draw those funds, and it’s just to cover the lender for the amount of risk that they’re taking on.
But it just depends on what your goals are, but it’s not a bad idea to go get as much of a HELOC as you possibly can to have that war chest if you need it. You’re going to pay a little bit more in interest. But if you’re a savvy investor and you’re being wise with your money and you have lots of reserves, it’s nice to have that in case what if you needed just $30,000 more to take down a really awesome property across the street where someone, there was a weird situation, you happen to be able to come in and get this property but you didn’t quite get enough HELOC to be able to do that because you were trying to save a quarter point on the interest rate when you were signing up for it. Just a couple of things to keep in mind as you’re taking them out.

Rob:
Man, I think I have a dream HELOC. I got this HELOC maybe five years ago. What is it, 2023? Yeah, probably about five years ago, six years ago. And it’s like I think a 3% interest rate, 90% LTV HELOC.

Kyle:
Whoa.

Rob:
Yeah, I know. Yeah. So I need to go find that and use it, but I have several times. But it is just interesting how the terms often change depending on the actual climate that we’re in. And it’s clear now with everything going on, the HELOC terms have changed quite a bit. One thing I wanted to ask you though was when you’re comparing a HELOC to a cash-out refi, I feel like there’s several reasons why one is more appealing than the other, me being more pro-HELOC. But when you’re doing a HELOC, are there as many closing costs or fees associated than with a cash-out refi? Because getting a cash-out refi, even if you are going into a lower interest rate, it can be kind of expensive to process, right?

Kyle:
For sure. They are definitely cheaper than getting a primary residence loan. A lot of times, especially if you… I keep saying local credit union, but for some reason local credit unions just love these HELOCs and that seems to be where you get the best interest rates, the best terms.

Rob:
That’s where I got mine, by the way.

Kyle:
Yeah. They really are in that market. The big huge institutions, there’s a lot more hoops to jump through. They shy away from them. For some reason, it’s a local thing that they like to do. But yeah, definitely the qualification is maybe a little bit easier from the paperwork standpoint, but the closing costs and stuff are definitely not as cumbersome as if you do a complete cash-out refinance.

Rob:
So you mentioned I had a couple of strategies that are perfect for the HELOC method, but do you have any ideas or any other ideas or strategies that someone could use a HELOC for?

Kyle:
The first one that comes to mind is something where you can get a quick return on the money. So what I mean by that is say you have a property. I’ll use an example, what we did with one of our short-term rentals this last year. The short-term rental is a six bedroom, three bath, and it also has two great rooms and it has a hot tub room, highly not recommended. So we basically, we moved the hot tub outside. We spent about $35,000 on a HELOC, moved the hot tub outside, turned that into a bedroom, added a bathroom which was already there with a vanity, a pretty cheap renovation to be able to add a bathroom in a bedroom in this resort town on a house like this. So we went from a six-three to a seven-four and we paid it off within a year. So that’s with a HELOC, with the amount that we were able to increase in rents on that property for the short-term rental, we were able to pay that off just in one year of using the property.
So a HELOC, I give that illustration to emphasize a HELOC is a really good short-term, get it done now type of thing. It’s cash that you can buy a property for cash if one comes up. This is a really good way to use it. If you have a very big HELOC and a house comes on the market and say it’s listed for 300 but you can offer 225 cash and you know there’s some value there, it really allows you to take something down that you don’t have to wait for financing in that whole process with the seller. And down the road when you do some renovations, if you read David’s book and do some brewing or whatever you have planned for it, you can put some new permanent financing on it and pay your HELOC back down, that higher interest rate back down, get that out of there, put that nice 30-year fixed mortgage on a single-family rental if you have that. But those are, I generally try to paint it in short-term pictures because if you get long-term with a HELOC, you start running into cashflow issues. You run into interest rate uncertainty.
So for example, if you use a HELOC as a down payment on a new property and you also put a mortgage on that property, the downside of that is now you have a 100% finance property, which sounds awesome. It is amazing from an ROI standpoint, but it gets really hard to cashflow and you can get really tight really fast if you don’t have a good exit plan for putting that all in permanent financing and getting that rid of that HELOC, that down payment portion of it. So I generally try to think of it as just your quick hit something that you can get your high return on the money, like doing a quick renovation that adds $100,000 in value to the house and also increases rent so much that you’re able to pay that HELOC off really quick within the next year or two.

Rob:
Yeah.

Kyle:
But I mean you hit them really good with your examples earlier.

Rob:
No, man, I like that. Actually, just hearing you say that, because I’ve got a flip right now that I wasn’t intending to do a full flip. It was supposed to be a quick whole tale, but looks like the move or the more profitable strategy is doing a full flip which is going to require another 65,000. And I could go the hard money route and all that good stuff, but I’ve got this HELOC and I’m like, “Oh duh, why don’t I just use that?” I honestly forgot about it until this conversation. I haven’t used it in a while.

David:
That’s funny.

Kyle:
That’s awesome.

David:
That happens to me all the time. In the middle of recording, I’m like, “I could do that too. Damn it. I didn’t think about that at all.”

Rob:
It’s like finding $65,000 in your jean pocket.

David:
One of the things Rob’s been hitting really hard is investing money into properties you already have, specifically short-term rentals to improve their performance, right?

Rob:
Mm-hmm.

David:
So in this case, you take 40 grand, you use it to build a tree house on your property, it makes you another 30 grand that year. About 1.25 years, you’ve now paid off that HELOC. It paid for itself and you have the tree house and the property that would rent for more. That’s a great example of what we’re describing here, as opposed to what everyone’s mind goes to, which is pull out the money, buy a whole new property. Well, now that property doesn’t cashflow or if it cashflows a little bit, it doesn’t cashflow with the additional debt of the HELOC. It’s incredibly difficult to find something new to buy that’s going to cashflow, but improving what you’ve already got, using the money to finish out a basement, using the money to improve an ADU that now could be rented out and have the HELOC payback makes a lot of sense.

Rob:
Although I’m going to say I’m a little broken-hearted. You got rid of the hot tub room. That sounds awesome.

Kyle:
That is anything but awesome. It looks awesome in the pictures for getting it rented, but then when 16 people move out of it and there’s like a pool of water across the tile floor and you don’t know where to put it…

Rob:
Duly noted.

Kyle:
It’s not all that awesome.

David:
Was it heart-shaped? It

Kyle:
It was not heart-shaped, no.

David:
I have a cabin I bought with a heart-shaped hot tub. It really does have one. And I didn’t notice it in the pictures when I was buying it and when I walked it, I was like, “This is that Dumb and Dumber scene when they’re sitting in the tub and they both got their side of the heart.” It’s like some Philly break your heart. It was just like that.

Kyle:
That is so good. I found old Zillow listing pictures from the owner before we bought it and it used to be an elevated hot tub up on a platform with red lights in the room. It looked… Yeah, I don’t even know what movie reference you would describe with that one. But yeah, it’s good to have it outside, for sure.

Rob:
So one other interesting method that I’ve seen people use HELOCs for is PML, private money lending. They’ll do HELOC arbitrage where they basically will take the interest rate that they have and then they’ll charge a higher interest rate to someone coming in borrowing it from them, and they make a delta on that. Have you ever gone down that road with using your HELOC for something in that space?

Kyle:
I have not personally done that. I’ve done that with an investor through I’ve borrowed from someone and I know it was their HELOC and paid them back. So that’s something that definitely is something that goes on. I would say a caution that I have, unless you want to lend to me, but the caution I would have is you just really got to make sure who you’re lending to. And of course that goes in any lending environment. But when you go on a HELOC, it just ups the ante a little bit because you have a variable rate on that HELOC most likely. And if you run into an issue or interest rates or you lend it out in the spring of 2022 and interest rates start ratcheting up on your HELOC and they’re paying you back at a lower interest rate that you thought was a good hard money rate but no longer is, you can just run into some stuff there. Nothing wrong with doing it, especially if it’s someone that you’ve lent to and they have some seasoned track record to go that route. But yeah, that’s definitely something that’s out there.

Rob:
You got to be careful, especially if your house is a collateral. If you loan out money from a bank account that your savings or something, you’re on the hook for that amount of money. But when you use a HELOC, your house is on the hook. So be very, very weary and know who you’re lending to in all situations.
I know I just learned some things about how to use HELOCs and I imagine our listeners are too. And after the break, Kyle teaches us about how investors can leverage a 401(k) or Roth IRA and what most people get wrong about this strategy, including me. So if you want to learn from my mistakes, you’re going to want to stick around until after the break.

David:
Welcome back. And if you’ve been sitting on pins and needles waiting to hear what type of mistakes Rob Abasolo makes, you’re in luck because getting into that now with Kyle Mast, talking about the best strategies that investors can use to tap into their equity.

Rob:
Now, Kyle, I understand there is another popular way to access funds to mine real estate and that is a 401(k) loan. Can you explain what that is? Because I think a lot of people don’t realize that this is a super powerful tool and the interest on it can actually be relatively beneficial, I think.

Kyle:
Yeah, this is a cool way to go. And I should say before we get into talking about some retirement account stuff here, in general as a principle, I like having real estate and retirement accounts pretty separate. You can have real estate inside a self-directed IRA or even a self-directed solo 401(k), and if that’s the only way that you can get into real estate, then that might be a good route to go. But in my experience, the tax code is written really well for real estate. We have in the US some of the best thing the government has known for decades that real estate drives jobs, drives economies, so they incentivize it incredibly with the tax code.

Rob:
Big time.

Kyle:
And the tax code is built well for real estate by itself. When you start doing it with a retirement account or putting it inside a retirement account, some of those can get missed, lost, or even messed up those benefits from a tax standpoint. So just a caution there. I.
N general, I like people having diversification, having some retirement accounts and having your properties separate, but you can have best of both worlds sometimes and sometimes in a shorter timeframe. With a 401(k) loan, usually it’s up to $50,000 that you can borrow from your 401(k), and it can be with an employer and it can actually be your own solo 401(k) if you are your own employer. This is what I’ve done in the past before I sold the business. I did this with my own solo 401(k) to buy a property and paid it back. But you can borrow the money and then you make payments to yourself as the bank back into your 401(k) account with interest, which sounds silly because I’m lending it to myself, why do I have to pay interest? But that’s how it’s stipulated in the IRS code and how you’re able to do it without it being a early withdrawal where you would pay a penalty on it or income tax on it.
So you can pull that $50,000 out and you don’t pay tax on it like a withdrawal. But when you pay it back, that interest that you’re paying back goes right into your account, adds to your account. The downside is you’re paying it back with after-tax dollars, which your whole account is pre-tax dollars for this type of loan usually. And now you’re mixing in some money that you paid tax on and then you’ll actually double-tax. You’ll pay tax on it again when you pull it out because you’re paying that interest, but it’s negligible in the long run. It’s just something that’s not super efficient from a tax standpoint.

Rob:
Yeah, that makes sense. So if I’m hearing this correctly, because this is how one of mine was set up. If you borrow let’s say $50,000, depending on who your brokerage is and the stipulations, you might have to pay a 4% interest rate to borrow that $50,000. But that 4% interest, you are paying to yourself. And now you’re saying while that’s cool that you’re getting that extra interest, you’re paying that extra interest with post-tax dollars and you’re mixing post-tax and pre-tax, is that what you’re getting at?

Kyle:
Yeah. You’re losing some of the benefit because you’re paying tax on that money that you have to pay back in interest. And then with a traditional 401(k) account, when you withdraw it out in retirement, you pay tax on everything you draw out and you pay tax on that amount as if it had gone in pre-tax, which it didn’t. So you get double-taxed on it. But like I said, it’s really negligible in the long run if it helps you buy a good property and helps you get into something.
A couple other things I should mention with the 401(k) loan too. You need to really pay attention to the plan documents at your employer. So in general, you have about five years to pay it back. That’s a pretty standard rule unless you’re buying a primary residence. So if you’re buying a primary residence with that loan, you’re using it for down payment, you’re using it for helping with closing costs, then you usually have 15, even sometimes 25 years-

Rob:
Oh, wow.

Kyle:
… depending on your plan document that you can really stretch it out. And that’s where it starts to really make some sense because that becomes a fairly low payment in the grand scheme of things helps you leverage into a primary residence that can then give you some leveraged growth over time as long as you’re not stretching yourself too far. But as long as you’re using it for a good asset, you’re not losing out on the compounding interest that you would otherwise get in the 401(k). When you take that 50,000 out, it’s no longer working for you in the 401(k). You got to put it to work in whatever you’re going to invest it in.

Rob:
That’s what I was going to ask. Okay, so the moment you tap into that $50,000, it’s no longer making you, let’s say a 7 to 12% return in the stock market or wherever it’s invested.

Kyle:
Yep.

Rob:
Okay, that’s good to know. That’s super big.

Kyle:
So you just want to make sure you put it into something that is going to do that well or better. That’s a pretty easy arbitrage way to look at it.

David:
That’s a great point to make for investing in general though. Opportunity costs is referred to in economics. If I use the money for X, I can’t use it for Y. A lot of people are obsessed with cashflow investing, just where can I get cashflow? Meanwhile, they’re paying $3,500 a month in rent. Well, if you house hacked and you only had to pay $1,500 to cover your housing and you’re saving $2,000 a month, that is even better than if you made $2,000 a month in cashflow because it’s not being taxed. There’s an opportunity cost there. And I think sometimes we get these goggles where we’re just like, “Have to find cashflow,” and you miss all these opportunities that you would have to make money in other ways.
And that’s a great example of it. Yeah, if you take it out, you were making 7% on it. If you invest in real estate that cashflow is 6%, you might actually be losing a percent unless you’re getting something like appreciation or a loan pay down or you have some kind of strategy there. So I’m always a proponent of teaching people how to look at their finances holistically, how do all these pieces fit together as opposed to just trying to line up a whole bunch of rental properties and think that that’s the only way to buy wealth. Is that something, Kyle, in your experience that you’ve noticed that investors can get those blinders on and sometimes chase after pennies and miss dollars?

Kyle:
Oh my goodness. If I could scream that from the rooftops, I would. You just nailed something that people miss all the time, especially if you’re good at what you do. Whether you’re a business owner, an employee, or a good real estate investor, the problem is that you get really good and you get really fast and you grow really fast and you start missing some of the things along the way. The taxes is one of the huge things that people will miss with just a little bit of tax planning. Once you start really rolling, you can save yourself hundreds of thousands of dollars a year if you pay attention to it.
So I definitely, and that’s one of the wonderful things about real estate. There are so many little avenues to the opportunity cost your way into something a little bit better and optimize something a little bit more. And depending on what your goals are, whether it’s to get really big with a whole bunch of rental properties, whether it’s to retire early, have time with the family, travel a lot, you can do any of those things and it helps so much if you’re not just looking at accumulating 3 to $400 cash flowing properties up to a certain point. That’s not the whole picture. The whole picture is what are your expenses, how can you reduce them, what is your income, how can you increase it, and what pieces go into that? Taxes, all these different things.
Credit card hacking is something that people just blow by when they have huge revenues in a business. And you could be having your family travel everywhere for free for the rest of your life just by doing a little credit card hacking. We’re off-topic, but you’re getting me going. This is exactly, people need to look at their whole financial picture, not just accumulating rental properties, for sure.

Rob:
Yeah. I want to move us a little bit along because we’ve nailed the 401(k) side of this too, but there’s the 401(k) counterpart, if you will, and that is the Roth IRA. Are there similar strategies or things you can do with the Roth IRA to buy real estate?

Kyle:
The Roth IRA is my favorite account of all time. It just really is this wonderful account that does so many things.
One of the first things that people think of or if you Google what can I use or how can I buy a house with a Roth IRA, the first thing you’re probably going to see is the first time home buyer exemption where you can use $10,000 from a Roth IRA tax-free, penalty-free, pull it out and use it towards the purchase of a home. And that’s awesome. Anytime you pull out a retirement account before age 59 and a half, you get hit with a 10% penalty in a normal situation. This is a situation where you could pull 10,000 out. You don’t pay tax on it. You don’t pay a penalty on it. You can use it. That’s awesome.
Bigger picture stuff with a Roth IRA, all of the money that you put into a Roth IRA, all of the contributions over the year, you can draw out at any time before 59 and a half. The growth, you cannot. You can draw it out with a penalty but you can’t draw it out penalty-free. And I should step back. A Roth IRA is where you put in after-tax money, it grows tax-free, comes out tax-free in retirement as opposed to a traditional 401(k) or a traditional IRA where you go in pre-tax, don’t pay tax now, grows tax deferred, you pull it out and pay tax. So the Roth IRA, you’ve already paid tax. That’s it. All the contributions over time go into that account, grow tax-free, come out tax-free in the future.
And one of the main reasons I like a Roth IRA is that say from age 20 to 30, you’re working a good job, you’re maxing out your Roth IRA each year, doing some 401(k), buying a few rental properties. And you get to 30 and you’re like, “Well, at 35 I could probably leave my job and just go rental properties and do this whole thing full-time. I’ve got some Roth IRA money here. Oh, I’ve got maybe 100,000 in here in contributions that I’ve…” That’s maybe high, let’s say 50,000 in contributions that I’ve put in here. The account’s worth 100,000. You can take that 50,000 out tax-free, penalty-free. Those were contributions you already paid tax on them. You can buy a rental property with them, leave the 50,000 in growth in there to grow to help you in retirement age as cashflow in the future. You can do that.
And then there’s a few other things that we can get into too on the Roth IRA, but that’s one of the most powerful things. And I just always tell people if you can especially early on really rock that Roth IRA because that will just give you so much flexibility down the road for purchasing things that come up straight out of a retirement account.

Rob:
Oftentimes, I hear about a self-directed IRA. Is that what you’re talking about? Or is that another subset of the Roth IRA?

Kyle:
Yeah, that’s another subset. So the self-directed can be any type of retirement account. It could be Roth IRA, traditional IRA, solo 401(k). Those are usually the ones that you can do self-directed. And all that means is that you can then generally invest in things that are more non-traditional. And by non-traditional, I mean not stocks and bonds. You could invest in a rental property in there. But no, the Roth IRA, this is just how it functions. That’s the contributions go in. They grow tax-free, come out tax-free and your contributions, you can always pull out.
The one thing that if you’re serious about real estate investing, and I wish every real estate investor would know this, is that if you at some point make the transition from a W2 job to a full-time real estate investor, that first year or two that you make that transition, what happens to your income on paper in taxes, you’re making 150,000 at a job, what happens in the first year or two when you become a, quote, real estate investor? Do you have any income?

Rob:
Well, yeah. Most banks will say no.

Kyle:
Zero.

Rob:
Even if you do. Yeah, for two years usually.

Kyle:
The whole point of saying it is that when you become full-time into real estate, there are so many deductions that on paper from a tax standpoint, your income is almost nothing.

Rob:
Oh, I see.

Kyle:
And what that does is it gives you this incredible opportunity that if you have a 401(k) from that previous employer, you can start converting that money to Roth money. And you usually only have a year or two window because it’s these first years into real estate investing, you’ve got a whole bunch of depreciation coming from your properties and you’re even bootstrapping it a little bit trying to make the transition and you’re not making quite as much. So you’re going to have low income. And you’ve maybe got a couple little tax deductions running around in your living room, tax credits that you can use on your taxes. And those can offset income.
You could convert 50 to $100,000 of traditional IRA money to a Roth IRA and that would be the same as converting 401(k) money to a Roth IRA completely tax-free because you have a standard deduction. You’ve got tax credits from your three kids at home. You’ve got all these deductions from your rental properties. But that opportunity goes away pretty quick once your cashflow starts coming in a little bit more from those rental properties. And then at that point down the road, you’ll have to pay tax pulling those funds out of those retirement accounts. So if you can use that opportunity to pay nothing in tax and get those monies from a traditional pay tax later account into a Roth account where you never pay tax later, it’s a huge opportunity. If I could just, everyone when they make that transition, pay attention to that because it’s an opportunity that comes and then it’s gone.

Rob:
I did not pay attention to that when I quit my job a couple of years ago, and now I wish that I would’ve had this podcast. So hopefully you’ve saved somebody.

Kyle:
Yeah, sorry.

Rob:
This moment. No, it’s fine. It’s fine. Hey. So what is the first time home buyer exemption whenever you’re using a Roth IRA? There’s something in this space too, yeah?

Kyle:
Yeah. That’s the $10,000. The first-time home buyer exemption is when you can pull out $10,000 and you don’t have to worry about whether it’s contributions or whether it’s growth. You can just use that, pull it out just like you were pulling it out of a bank account, and use it towards closing costs, down payment, any expenses associated with buying a primary first-time residence.

David:
All right, when it comes to buying a house, any other creative ways or paths that people should think about when they want to buy a property?

Kyle:
I don’t. There’s really no silver bullets out there. I think we covered a lot of really good ones here. There’s none that come to mind in addition to what we’re talking about. I think one of the things that you guys hit home all the time is just the house hacking piece. A lot of these things that we’re talking about work really well for a primary residence, a first-time home buyer. And if you can just make sure you take advantage of that, especially the early years in the career when sometimes there’s some income qualification stuff where you can get a better loan through a certain government program, because those years go by and you’re not able to use it anymore. And the earlier you start, the better on those. So yeah, there’s no silver bullet. But it’s also not a real hard thing to do if you just start doing it.

David:
All right, Kyle, good stuff. Thank you for your contributions today. Had a good time learning about HELOCs, cash-out refinances, equity, and most importantly, equity options that people can use to improve their portfolio or expand it in the right circumstances. And Rob, I just want to say you’re particularly good today too. You’ve been stepping up your game.

Rob:
Thanks, Dad. Appreciate it.

David:
Kyle, I’m going to let you get out of here. If you guys liked Kyle, you can catch him as a frequent contributor on the BiggerPockets Money Podcast. But we’re all done for today. This is David Greene for Rob “Buy Nice Not Thrice” Abasolo…

Rob:
That’s me.

David:
… signing off.