Borrow from 401k to invest in real estate

20 Replies

Is it good idea to use funds from 401K to buy a cash flowing SFR? I have about 105k in 401k. Minimum payment will come out of my biweekly paycheck to pay off the borrowed money.

What are the pros/cons of doing this? I I understand that I will lose out on any potential on borrowed money if I were to leave enact.

I’ve heard about paying interest back to myself when I’m paying the loan back, little confused on this concept.

Thank you for the help

Are you thinking of doing a self directed 401k? I think you should look into that. You can roll your money into that and use and then you can pay yourself back with interest there and loan again as many times as you want to.

Hi Narinder,

Congratulations on getting resourceful in REI. It separates a lot of the wannabe investors and the investors on their path to their goals. I have borrowed from my 401k, cashed out IRA's, borrowed from non-term life insurance policies to name a few in my conquest to obtain more real estate and reach my goals. I think its a good option purely because I trust myself to make more cash and equity in REI than I trust Fidelity to grow my 401K.

I typically follow a BRRRR strategy where I buy the property, rehab it, rent it, refinance it and repeat the process. The refinance typically cashes me out all my funds invested and I repeat the process. So when I have borrowed from a 401k previously I typically look to repay it within a year. MY understanding, During that time when you have the loan out you are paying interest to yourself to keep your 401k on track. So lets say you borrowed $100k out of your 401k, bought a property, held it a year doing some renovations and then refinanced your cash out you would be making loan payments to the 401k. Lets say you have an 8% interest agreement it means that if you held it a year you would pay $8k interest over that year, so your $100k 401k will be worth $108k with the interest you paid. Plus you will hopefully have built equity in the property and made cashflow.

I am sure others will chime in with their opinions but I find myself leveraging as much resources as possible to accelerate me to my goals.

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@Michele Wax I do have a another SDIRA and I was told that that's something I can not do with IRA but can borrow against the 401k to 50%. Unless I do some sort of QRP set up with that SDIRA.

Do you any additional information on it?

I am also interested in completely closing out and withdrawing all previous employers 401K funds to buy cash flowing rentals.  Like most (I assume) I am really nervous about this irreversible decision.  Taxes and penalties will be gone forever.    I have done the math and IF all assumptions are correct then this would be a better decision for me down the road.  Most of the internet, other than this site says this is a terrible idea.  What can I do to convince myself this is a good decision when there is such an immediate drop (on paper) of my net worth.

@Craig McLaughlin

Have you compared taking a taxable and penalized distribution of those 401k funds to the concept of converting those funds to a self-directed IRA.

The key differences are as follows:

With a distribution you cut your available cash by 35-50% on the front end with taxes and penalties.  This is now your cash that you can invest as you choose and personally draw the income.

With a self-directed IRA, you get to keep 100% of the funds. It is not your money to use as you choose today, however, but rather just a way to diversify your 401k savings out of the stock market and into real estate. All expenses are paid from the plan and all income is returned to the plan. This can be a great way to build your tax-sheltered retirement savings.

I think you need a financial adviser to sit down with you and explain how to hold onto your net worth, there are ways of doing this.  Rolling them all together and moving them forward.It is possible not to "Lose" money doing this and if your financial adviser says different you need a new one.

@Scott MacDonald with all this volatility in market there is no way to make any real money. Unless your a professional and do this for living. I participate because of the company matches up to 6%. I don’t want to lose out on free money.

Not to mention the fees they charge to do nothing. I have to do something else, I think with real estate I’ll have better control and it’s alot easier to understand. Tanker being blown up in other side of world doesn’t really affect my real estate investments on daily basis, where markets will plunge on news like that.

Thank you for your input

@Brian Eastman  I like to do a lot of work myself, so I am afraid that I'll violate some rule about a SDIRA and get hit with a huge tax bill some year when I am not expecting it.  I think if I were to go down this road it will be with funds that I have withdrawn and paid the taxes and penalties on so there is no surprises.  For now anyway. 

@Craig McLaughlin

Point taken. How hands on are you with the stock market? Do you write code for Apple on behalf of your IRA? No, of course not.

An IRA is not your money today, regardless of what you are investing in. This is special tax-sheltered savings for your future self.

Thinking "I would like to invest in real estate" and looking to your IRA for funding is a disaster in waiting.

Thinking "I understand real estate and can produce better returns for my IRA investing in real estate at arms' length" is the way to approach these plans.

Originally posted by @Craig McLaughlin:

I am also interested in completely closing out and withdrawing all previous employers 401K funds to buy cash flowing rentals.  Like most (I assume) I am really nervous about this irreversible decision.  Taxes and penalties will be gone forever.    I have done the math and IF all assumptions are correct then this would be a better decision for me down the road.  Most of the internet, other than this site says this is a terrible idea.  What can I do to convince myself this is a good decision when there is such an immediate drop (on paper) of my net worth.

Craig,

I actually agree that cashing out of your 401k, paying the taxes and the 10% penalty is a BAD idea - specially if you're a newbie real estate investor. Doing the number on paper is just that - it's a numbers exercise. The reality could be totally different than what you project on paper specially if you have not done any investing.

Now, the story is different if you have done, say 10 rental properties and all of them achieved a 30% ROI. In that case, then it makes sense to cash out the 401k, specially, if even if your 401k is cut in half, it will allow you to buy 10 more rental properties!

Keep in mind that you will be most likely paying back tax free money with after tax money and then paying taxes on it again once you eventually draw from that account in retirement. It will also be a plus to have your investments diversified across stocks vs. real estate.   

@Narinder Gill

Right now, it’s a great plan to take out a 401k loan to buy rental properties. The stock market has been stagnant since January 2018. If you’d taken out said loan 18 months ago, the interest you’d have paid yourself, plus the appreciating asset and cash flow would have been a better return than your 401k.

Now, the cons. You lose your job and the loan becomes a taxable distribution (plus 10% penalty). And, if the stock market suddenly has a 20% gain you will miss out on that. But more than likely your loan will make more money in real estate than your 401k.

@Craig McLaughlin I was in the same spot as you a while back. I had an old 401k I from a previous employer, no clue what to do with those funds. I didn't want to withdraw and lose a huge chunk of cash. And being a high-income W2 earner, rolling into a Roth was not an option. So I opened a traditional IRA instead. And now that money invests in real estate notes, tax-deferred until I'm old and gray (and it is far less complicated than owning real estate directly). I HIGHLY encourage you to look into self-directed IRAs and all the options you can invest in.

@Rebecca Jackson I’ve done same as you, minus the note investing business or any real estate investing with the funds. I have been playing stock market for a 9 month and so far made nothing. Would like learn more other options.

How can I invest the SDIRA funds into some sort real estate investments?

Thank you

@Narinder Gill I really like Equity Trust. They have a lot of educational material for what you can do with your retirement funds within the scope of the tax laws. I’d start there and see where that takes you. Good luck!

Originally posted by @Rebecca Jackson:

@Narinder Gill I really like Equity Trust. They have a lot of educational material for what you can do with your retirement funds within the scope of the tax laws. I’d start there and see where that takes you. Good luck!

There are several providers of self-directed IRAs and 401ks who regularly participate in these forums on Bigger Pockets as well. You might want to check with some providers of checkbook control type accounts and compare these to custodial options. 

@Narinder Gill

I really like the idea of being able to borrow against your 401K to invest in real estate.

It is a cheap form of capital.
Depending on your employer, there may be no fees to set up the loan.
Furthermore, the interest that you would be paying back to yourself is normally a low rate.
The big cost is likely the lost tax deferred earnings that you would be earning if the funds were still in your 401K.
This can be offset big time if you are able to acquire a piece of real estate below value.

You may be expected to return the funds to the 401K upon quitting or being fired. Failure to do so may result in the funds being classified as a distribution and taxable on your tax return.

I still love the idea and I personally did it to purchase real estate.

My wife has a 401k at her job.  It's through Vanguard.  The max loan is $50K.  We borrowed $46K earlier this year.  She set up a 5 year payback and interest she paid that went into her account was 6.5%.

We bought a house for $24K and had a complete renovation done for $22K.  The appraisal then came in at $77K.  We then refinanced it for $51,500.  When we received the money, we completely paid off the loan.  We are required to wait at least 2 weeks until we can borrow it again.  We also paid closing costs from this money and still had a few thousand left for us.

The process of buying it and getting it refinanced took us exactly 6 months. 

We are looking for another BRRRR house so we can do this again.

@Mark K.

That sounds great, congrats! Just be aware that with participant loans, the amount you can borrow is generally reduced by the highest outstanding loan balance in the previous 12 month period. You might want to check with your plan administrator for this or any other restrictions the plan may have on taking additional loans.