401K for first real estate investment

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401K for first real estate investment

Liam Martin
Boston, MA · Member since 2020 · 14 posts · 4 votes

Hey BP,

I am in the process of buying my first rental property. I live just outside of Boston, MA and plan to buy a property within 30 minutes of my current residence using FHA financing. I found a couple of deals that could make sense and have confirmed my analysis with a fellow investor to ensure my numbers are correct. This area is loaded with rental properties, but most are on the expensive side.

I have a good amount of cash saved up for the down payment, however, some properties that are just slightly out of my price range have even better potential for ROI.

I wanted to hear some thoughts on taking an early withdrawal from ones 401k to fund part of a real estate investment. Since I am 24, live with my parents, and have very few expenses, I’ve contributed rather aggressively to my 401k for the past 1.5 years and have plenty of money in it. I am aware of the penalties and taxes associated with an early withdrawal but feel that leveraging this money to contribute to a buy and hold rental is worth it in the long run.

Based on the above, does this sound like a reasonable decision or is it short sighted? All responses are greatly appreciated!!!

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Aaron Montague
Rental Property Investor · Brookline, MA · Member since 2013 · 1k+ posts · 777 votes
5y

@Liam Martin

Don't do an early withdrawal, take a loan:

https://www.investopedia.com/a...

As long as you don't plan on leaving your job soon, the 401k loan is a solid way to add a bit more cash to the deal.

Focus on paying the loan back so it isn't hanging over your head and then you will be back on track.

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  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    Not really sure what happened to the formatting here! Sorry about that

    0Reply
  • Aaron Clough
    Real Estate Agent · DFW Metroplex · Member since 2020 · 9 posts · 4 votes
    5y

    @Liam Martin Just out of curiosity why FHA on this property? I'm not a lender, I'm an agent, but one criteria that I've always heard for FHA loan is that it's on a primary residence. That's not to say that if you live in the home you can't rent it out later but not outright.

    2Reply
  • Aaron Montague
    Rental Property Investor · Brookline, MA · Member since 2013 · 1k+ posts · 777 votes
    5y

    @Liam Martin

    Don't do an early withdrawal, take a loan:

    https://www.investopedia.com/a...

    As long as you don't plan on leaving your job soon, the 401k loan is a solid way to add a bit more cash to the deal.

    Focus on paying the loan back so it isn't hanging over your head and then you will be back on track.

    8Reply
  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    @Aaron Clough hi Aaron, this would be my primary residence, as I would live in one unit and rent out the other.

    1Reply
  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    @Aaron Montague hi Aaron, that is an excellent point. Looks like a loan might be the way to go. The article you included on your response was extremely helpful as well. Thank you for your insight, I appreciate it!

    0Reply
  • Lien VuongBusiness Member
    Real Estate Agent · Boston, MA · Member since 2018 · 2k+ posts · 1k+ votes
    5y

    Totally fine as long as you're not over extended and have a reserve set in place for vacancy and repairs upon closing (3 months mortgage at min. and however much you allocate to repairs depending on condition of property). 

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    1Reply
  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    @Lien Vuong Hi Lien, thank you very much for your insight. That is a great rule of thumb, I will definitely use that moving forward.

    I’m sure this depends on the individual and a number of other factors, but would you recommend a withdrawal over a loan or vice versa? And why?

    0Reply
  • Michael Cox
    Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 7 votes
    5y

    @Liam Martin I would recommend taking a loan out instead (usually at extremely low rates), and you’ll pay it back through your pay checks.

    You could also calculate/estimate the hit to your taxes and incorporate that into your ROI and CoCR calculations to see if it changes the attractiveness of the investment.

    0Reply
  • Bradley Padula
    Rental Property Investor · Boston, MA · Member since 2019 · 124 posts · 121 votes
    5y

    If anything, wait until you absolutely need to draw on the funds or take a loan, if you decide to. Otherwise they're sitting in your bank account doing nothing. 

    A 401k loan could be a good tool here, but be aware that your lender will have to factor your monthly payment obligation on the loan into your DTI (debt to income calculation) when they determine how large of a loan you can get

    So you may pull out say, 10k, 20k, 30k etc, to have more of a downpayment fund available, but make sure you aren't shooting yourself in the foot by then limiting how large of a loan you can get due to DTI increasing, which would make the 401k loan/money a waste to take out

    I'd recommend getting on the phone with your lender and asking them about this. Something along the lines of I have this much now for a downpayment and based on DTI you say you'll loan me max of XXX, if I had an additional $xx thousand available on a downpayment, in theory I have enough of a downpayment for a more expensive house, but will that larger loan work with where my DTI will be add taking into account the monthly debt you're incurring

    I'm local and own 3 units, drop me a message anytime if you want to connect on a call!

    2Reply
  • Michael A.
    Investor · Richmond, VA · Member since 2016 · 164 posts · 114 votes
    5y

    I'm an advocate of NOT touching your 401k. If you aren't interested in contributing to it anymore and want to exclusively save and invest in real estate going forward then do that. But that 401k that you started at VERY early age is likely going to be a very secure nest egg to fall back on way down the road in case something happens to you. If it's inconsequential to leave it alone I would do so. $35,000 in a 401k at your age right now will be $1,000,000 when you retire if you never contribute another dime for the rest of your life and buy an S&P 500 mutual fund. Everyone here obviously believes in the awesome power of REI, but I wouldn't throw caution to the wind and destroy this excellent potential nest egg you have. And besides, you already have a down payment on a property in addition to it! You sound very financially responsible. And good on you for sucking it up and living at home while you stockpile cash. Most young people are too vain to entertain that, so they throw money away on rent in a cool downtown neighborhood 20 minutes away from their parents so their Instagram posts are cooler.

    2Reply
  • Dominic R.
    Bethany, CT · Member since 2017 · 37 posts · 16 votes
    5y

    Remember that If you lose your job for any reason, there’s a good chance your plan will either require you to repay the loan fairly quickly or will end up reducing your account balance by the amount owed and consider it a distribution. I would never recommend touching a 401K. 

    0Reply
  • Justin Phillips
    Lender · Phoenix, AZ · Member since 2018 · 440 posts · 256 votes
    5y

    Everyone has pretty much already said it, but a loan is the way to go when working with 401k. The best recommendation I can provide though, is patience. You don't want to touch your 401k for a stretch of a deal. Great deals are definitely out there, but with this crazy market, they're much tougher to find. I'm 24 as well, and I'm just reminding myself that I'm young, and there will be many RE cycles before I'm ready to retire. 

    0Reply
  • Tim S.
    Investor · California, CA · Member since 2016 · 367 posts · 375 votes
    5y

    If the 401k is with a previous employer then you can move it to a self directed IRA, from which you can invest in real estate without triggering a withdrawal. There are some significant restrictions, but it is possible. I'm going to assume from your age that the 401K is with your current employer.

    0Reply
  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    @Michael Cox hi Michael, thanks for offering some insight on this, I appreciate it. I’m going to start including the loan in my analysis’ and see if some deals make sense. Thanks for the tip

    0Reply
  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    @Bradley Padula hi Bradley, thanks for this. I appreciate the detailed response and your willingness to help. I have been working with a loan officer, so I might pick his brain about some of the points you make here.

    1Reply
  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    @Dominic R. This is a great point Dominic thank you, I appreciate the response

    0Reply
  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    @Justin Phillips hey Justin, thanks for responding. Regardless of whether I go for a loan, withdrawal, I’ve promised myself that it has to be on an amazing deal. I couldn’t agree more about your recommendation on patience. We have plenty of time!

    0Reply
  • Liam Martin
    OP
    Boston, MA · Member since 2020 · 14 posts · 4 votes
    5y

    @Tim S. Hi Tim, thanks for responding. Yes, this is with my current employer.

    0Reply
  • Zachary Beach
    Specialist · Los Angeles, CA · Member since 2018 · 291 posts · 231 votes
    5y

    @Liam Martin

    It depends when do you want to be able to have financing freedom. I have 0$ in 401k's I had a vanguard but it was pathetic. I'm also 24 and will be financially free at 25. I'm not going to retire because I have taken a few months off at a time a few times already and it gets boring fast and I like working on my REI and STR management businesses. For me 401k has no realistic point it's returns are very low compared to active real estate invest unless you do individual stocks and are good at it and even then your better off with it not in 401k so that it can be used. Our generation isn't getting into 401k before we are 70 without penalty haha.

    A 401K is most good for a company match. If your company does a match get the most you can and then cash it out. There are some exceptions

    In your situation I would not rule out cashing out 401k if you have something with more than 20% higher return like house hack or brrrr already lined up. 401K loan is also a good option if you want to keep your 401k going forward.

    2Reply
  • Jenny Tenuta
    Rental Property Investor · Jacksonville, FL · Member since 2020 · 4 posts · 1 vote
    5y

    @Liam Martin

    We just used the 401k loan option for our first property. In our situation, they setup the loan payments to deduct directly from our paycheck. The interest rate is fairly low as well.

    Only downside I’ve seen so far is that if we were interested in making extra payments, that’s not an option. Either we have to stick to the payment schedule or pay off the remaining balance in one lump sum.

    1Reply
  • Matt Ziegler
    Rental Property Investor · Colorado Springs, CO · Member since 2020 · 433 posts · 284 votes
    5y

    @Liam Martin

    Look into taking a loan from your fund as opposed to an early withdrawal. That way you can access the funds and avoid the penalties.

    This can be a good way to make your money work for you.

    Enjoy the ride!

    0Reply
  • Jenning Y.
    Investor · USA · Member since 2015 · 168 posts · 243 votes
    5y

    @Liam Martin  

    I do not think there's anything wrong to cash out your 401k and invest in real estate. I know several people did that and were very successful.  You are so young even you screw up you still have chances to try again.  In the long run, real estate should beat the stock market due to leverage,  even after considering the early withdraw penalty, especially if you are located in an appreciation market.

    However, I must add a cautious note that doe not overextend yourself, keep enough reserve so you can survive the downturns.  For example, you can leave part of your money at 401k as cash reserve in case of emergency.   As long as you can survive the possible downturns, I do not think there's any problem with that. 
      

    2Reply
  • Matt Palmisano
    Rental Property Investor · Rochester, NY · Member since 2015 · 23 posts · 18 votes
    5y

    @Aaron Montague

    Aaron is right. If you can swing it, do a loan. That way you don’t pay the early withdraw penalties.

    0Reply
  • Fred Cannon
    Rental Property Investor · St Augustine, FL · Member since 2019 · 265 posts · 279 votes
    5y

    @Liam Martin the penalty for early withdrawal is very harsh. Does your 401 have a provision to make loans. That would be a better strategy I have used loans against my 401k to buy a few properties.

    1Reply
  • Jody Broussard
    Real Estate Investor · Wallisville, TX · Member since 2017 · 17 posts · 15 votes
    5y

    @Liam Martin Research "ROBS". Rollover business startup.

    0Reply
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