1st Property Problems

[Collin Ricter]

Good Afternoon,

I would love to get some input on my situation. We bought our first unit ( 3 BR x 2.5 BA) in February 2022 its currently rented out through March but is not cash flowing due to a few incorrect estimates on my part.

Some of these items are minor and will work out with time but the biggest blow to profitability is the HELOC we took against our primary residence to come up with the payment for the rental. I imagine everyone is dealing with rising rates so this is probably white noise but the rate on the HELOC went from 4.25% to 8.00% in approximately 6 months. I never intended to take the HELOC to term so the increase just adds a little more urgency to what I was already planning to do. I currently owe ~$72k so my thought now is to borrow from my 401K, max allowed is ~$50k pay myself back at ~5% or so, and come up with the remainder through aggressive saving and tax returns. Am I overlooking anything in this scenario or are there other viable options I should consider? Thanks

[Andrew Freed]

@Collin Ricter - If you grab from your 401K, will your stocks be sold? If so, everyone experienced a 10-20% decline hence selling at the low should also be taken into the equation. You're essentially taking a 10-20% loss on day one. Maybe you can utilize tax harvesting, it might make sense but something to consider.

If you are taking a loan against the stocks and not liquidating it, I could see arbitraging one debt at a lower rate and paying off a higher rate loan. Nonetheless if you have to sell the stock on a low to take out the loan, that would make me second guess this decision. 

[Kevin Sobilo]

@Collin Ricter, first off I would not count the HELOC on your primary residence against the rental income to determine if a property is cash-flowing. That is your seed money and personal debt not business debt. You could have just as easily blown that HELOC money on booze and hookers! lol. So, if you think of it as personal debt that is just more fair. Just as an aside if it was business debt the interest would be 100% deductible against the rental income, since its personal debt it may or may not be deductible depending on if you are able to itemize.

I understand that paying 5% back to your 401k sounds better than 8%, however what if you borrow and the market jumps 15% in the next year?!? You have LOST that 15% gain while paying yourself only 5%. This is why many folks don't recommend borrowing against a 401k. I'm not saying its a bad idea, but just be aware of that. Also, be aware that the interest you pay to your 401k is not tax deductive at all! 

[Mohammed Rahman]

Hey @Collin Ricter - instead of pulling the money out and possibly taking a tax hit, and a valuation hit, have you considered working with a bank to consolidate your debt with your 401k as collateral?

You might want to first start by reaching out to your 401k provider to see what type of programs they might offer to borrow against your own assets. You can write off the interest on borrowed money FYI. 

[Collin Ricter]

Thanks for the replies. I could have clarified better, I intended to use a 401K loan not pull out directly and I’m aware of the risk associated of it counting towards taxable income if I lose employment. I guess my bigger question is how can I get capital for more properties, paying this debt  off was just the first step in that process.

Perhaps the rate increases are slowing down but getting rid of the variable rate debt still seems like the best choice. 

[Nathan Gesner]

Quote from @Collin Ricter:

This is why I warn against people borrowing money (line of credit) to borrow money (new mortgage). Unless you can pay the line of credit back quickly, there's a high risk of over-leveraging and your life gets hard.

Don't borrow from the 401k to pay off the line of credit. Work hard, get some hustle, sacrifice, and pay it off the hard (aka: right) way.

[Scott E.]

Your options are:

1. Sell the rental property. Only do this if you can at least break even or profit a bit. Don't sell for a loss. This will allow you to wash your hands of the place, regroup, and buy back in next year.

2. Sell your primary. Only do this if you can profit a bit and you don't mind uprooting your family and putting them in a rental. This will allow you to keep your rental and pay off your HELOC.

3. Take a deep breath, and start chipping away at that HELOC balance right away.

Borrowing from your 401k is a horrible option, especially with how badly stocks have been beaten up this year.

[Chris Davidson]

@Collin Ricter are you contributing to your 401k now? If so what about taking those funds and paying down you heloc? You need to tighten up your budget and work on getting your HELOC paid down.

Without knowing your whole financial picture it is impossible to answer other than pay down the HELOC. If you are paying extra on debts less than 8% move those excess payments to the HELOC.

[Joseph Beilke]

If you have enough equity in the property and the DSCR is very good you might be able to talk with a lender and get yourself a fixed rate 2nd mortgage on the property with a short term of lets say 7-10 years. I bought a property once and got a 80/15 with 5% down. When I did some basic improvements I was able to refi with no cash out about 2 years later at 85% LTV. Lenders are starting to get creative again, I would start looking around before I pull from you 401K

[Collin Ricter]

I appreciate the input from everyone, other than a mortgage we don't carry debt, I've already reduced, but not eliminated, 401K contributions to manage the increased HELOC payment. Im nowhere near the point of urgency that I'd consider selling primary or investment at this point. What I'm hearing is a DSCR may be a distant option but overall I need to put the work in and start chipping away at the HELOC.