Newbie - Down Payments - Ways around them? Ways to fund them?

15 Replies

My wife and I have always wanted to get involved in real estate and have recently really begun studying on how to make it happen. We have 2 kids and are trying to create more free time spend with them. Through all the videos and reading I am struggling to find a way to fund a down payment on any property. I do not have the liquid cash. We are looking to flip or get into rentals. I have a 401K with about $40,000 and a vehicle worth $17,000 we own.  Is there any way to get started without having the liquid cash on hand for a down payment?

You are off to a great start!  Thinking outside of the box is the best way to find opportunities.

Your 401K is a HUGE resource!  Check the options available to you.  If it is parked with an employer, they will have rules about how much you can access at any given time and the terms for doing so.  Many companies will allow you to take a loan out against it for up to 50% of the value of the account.  For you, this would equate to $20K.  That's a good start toward a down payment.

You may have the option to withdrawal from your 401K.  I would advise against this if at all possible as it would require a 20% deduction for the taxes, and a 10% penalty fee.  OUCH!  However, if you borrow against it, you have use of the funds, and pay them back to the account over a short period of time.  You even pay interest to yourself on the loan amount.  So, your loan is also an investment!

Alternatively, if your 401K is leftover from a previous employer, and you can roll it into an IRA, you should consider a self directed REIT (Real Estate Investment Trust). REITs use the funds for real estate investment. If interested, you should explore options with your accountant to go over any tax implications to minimize your tax burden custom to your situation.

I would shy away from using your car to build cash for a down payment.  Taking on a car loan will increase your debt, and may throw off your debt to income ratio when qualifying.  

Accessing the 401K is your best option. If not you need to either cut your expenses or get a second job to generate more savings.

I would refrain from taking out from your 401k. It's tempting, but it won't benefit you.

"You even pay interest to yourself on the loan amount. So, your loan is also an investment!"

You will pay taxes on the same money twice. It is true that you pay yourself back with some interest, but you also use post-tax dollars to pay for those interest payments. When you use your pre-tax 401k money in retirement, those future interest distributions will be taxable as ordinary income this means you actually pay taxes twice on that money.

I second not touching the 401k, but for different reasons. If there is any chance you could possibly lose your job, that 401k loan will become due in full as soon as the termination paperwork makes its way through.

@cara lonsdale - as u stated I can loan up to 20,000 against my 401k. Doing this I could afford to buy a property in my area. It would be tough to make a rental work this way as you would owe on that loan but could flip houses this way. Would that be the best way for me to get started? Flipping houses until I can build enough liquid cash to do other things?

Originally posted by @Simon W. :

I would refrain from taking out from your 401k. It's tempting, but it won't benefit you.

"You even pay interest to yourself on the loan amount. So, your loan is also an investment!"

You will pay taxes on the same money twice. It is true that you pay yourself back with some interest, but you also use post-tax dollars to pay for those interest payments. When you use your pre-tax 401k money in retirement, those future interest distributions will be taxable as ordinary income this means you actually pay taxes twice on that money.

 If these are the only funds to work with, it is still the best option.  It is true that you use post-tax money to make the payments.  However, compare that to a loan provided by a lender??  ALL of that payment is made with post-taxed funds AND you don't get to keep the interest, then lender does, which is substantial in the beginning of the loan.

To speak to the post about leaving your employer and having the loan immediately due.  This is true, and something to consider.  However, it is not the only option.  If you are unable to pay back the loan at the time of discharge, you could take it as a withdrawal.  This is worst case scenario as it would require a 20% deduction for taxes and a 10% penalty for early withdrawal.

Again, the 401K is still a resource if no other resources for down payment exist.

Originally posted by @Nicholas Young :

@cara lonsdale - as u stated I can loan up to 20,000 against my 401k. Doing this I could afford to buy a property in my area. It would be tough to make a rental work this way as you would owe on that loan but could flip houses this way. Would that be the best way for me to get started? Flipping houses until I can build enough liquid cash to do other things?

 I would caution against doing a flip with limited funds.  Any rehab expenses or unknown items that present themselves during your flip will break your budget, and if you don't have enough funds for the purchase and the rehab (with contingency for unknown items), then you are treading on risky ground.

How set are you in staying in your current home where you are?  Would you consider moving your family into a new property and renting out your current home?  This could be an option that would minimize the amount of down payment because you would now be considered an owner occupied borrower instead of an investor.  Additionally, you already know the condition of your current property, so you would know what items would need repair prior to renting it out.  If rents in your community are favorable, it may be something to consider if other options are limited by your down payment.

I like Cara's suggestion on taking a loan against your 401K(it seems like your only immediate option at the moment).
I took a 15,000 loan against my 401K to fund my first investment property.

However, you should look into seeing if you can cut out other expenses going forward.

I would also avoid doing a flip for your first project. What happens if you miscalculate the repairs.
What is the original purchase price + repair budget was $30K and it comes out to $50K...you pretty much get screwed at that moment.

Sell the 17K vehicle and buy a reasonably priced, reliable, low maintenance used Toyota or Honda for under 10K. Having that much money invested in a depreciating asset is holding you back from building future wealth. You need the cash more than you need the fancy ride.

@cara Lonsdale

Thanks for all your info. We just built our home 2 years ago, I don't think I can convince my wife to move out of it :) If taking out a loan against my 401k is my best option and going the rental route is the way to go - how do you pay back the 401K loan? Do you have to make sure you have enough cash flow from the property to pay on both the 401k loan and the bank loan? I recently have been reading about BRRR's, would that be an option and cash out to pay off the 401K loan so I can continue to purchase properties? I appreciate all help!

@Basit Siddiqi

When you took out your loan against your 401k, did you just make sure the property was going to have enough cash flow to pay the bank and the 401k loan?

You pay back the 401k loan is through your paycheck. I do payroll and it gets deducted from your paycheck just like your regular 401k.

These two aren't your ONLY options, they are just your only current options. My vote is to save the cash for a down payment. The added stress from owning rentals when you are severely undercapitalized is far, far from worth it. Keep working hard, keep the long term goal in mind. Save up.

401k is for retirement, it's $$ you should never touch until you're retired. Unless it is an emergency. Buying an investment is not an emergency.

Why even people are suggesting this is beyond me. Save up a bit more. Ask for friends and family to partner up if interest. Go to meetup groups to find partners. Go find a lender that will take the investment property as the only collateral so they won't go after your assets. There are ways if you are desperate enough. Think of the 401k you have does not exist. Sorta like you left a $100 bill in your pocket and years later you found it. 

@Nicholas Young ,

Take a loan on your 401K, you can do up to 50%,  and it's only a 5-year loan, and the payments are taken out automatically from your paychecks.     It's going to be your cheapest and easiest option!     That's the way I funded 1 of my houses, and haven't looked back!   They mail you the check quickly and then it's just automatically withdrawn--very easy.   There are no tax consequences because it's a loan, and not a withdrawal.   

If you do this, it's a mental obstacle to realize-- you aren't losing any money, you're just moving it from A to B.      If you take out $20K loan, you're leveraging yourself for $10K-$20K more a year in rent!  Think about how great it will be, in 5 years.. your 401K loan is paid back, and you got your rental with extra income... not to mention equity, IMO it's worth the risk.

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