401(k) Loans to Finance Rental

Garden City, NY · Member since 2021 · 19 posts · 5 votes

I am thinking about using a 401(k) loan to fund a property. I’ve read up on some of the risks involved. Looking for anyone with some real world experience to share some advice on what to do/not to do that you think would be helpful for others to know.

I haven’t spoken to my plan admin yet but want to come prepared with some additional knowledge if possible.

Thanks.

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Greg PowersPro Member

Real Estate Agent · Manchester, NH · Member since 2013 · 120 posts · 159 votes

@Eric Braxton, I used to work for a major plan provider and processed these loans all day long. They are VERY plan-specific, but they do have some great features:

1. As mentioned, there is an interest rate attached to them, but generally it is very low, and you pay the interest back to yourself into the plan.

2. There is no credit check required, and they are not reported to any credit agencies.

3. General loans usually have a 5-year term; some plans allow home loans which have a longer term (20 years?). General loans can be used for anything—downpayment, repairs, buying down an interest rate, car repairs, buying a new guitar…whatever you want.

4. Mortgage lenders do not count them against your debt-to-income ratio, so if you are using it as a downpayment for a mortgage it should not cause any problems on that front.

5. Some plans allow multiple loans either concurrently or sequentially (assuming you have enough in your account).

Downsides?

1. As mentioned, if you take the money out of your plan, it’s not working for you in the plan. But if you’re using it to buy a property with a better return than your retirement plan is getting, that’s actually an upside.

2. IRS limits you to borrowing $50,000 or 50% of your vested balance, whichever is less. Some plans are more restrictive.

3. If you stop paying it back, the loan will default. Many plans require them to be paid back via payroll deductions, so the only way to default on those is to leave your employer. However, if you do default, the unpaid balance becomes a distribution subject to ordinary income tax and possible a 10% early withdrawal penalty—but it will have no effect on your credit score or credit history since you just borrowed it from yourself. Defaulting May also have some plan-specific repercussions (some plans will restrict or eliminate your ability to borrow any more).

They can be a great tool if used correctly.

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William Sing
Real Estate Agent · Portland, OR · Member since 2020 · 278 posts · 136 votes
4y
Hey Eric! I have found it harder to find a seller in my market, Portland, OR, to be open to doing this. These loans typically have a bit more upfront cost and in competitive markets are not as desirable.
Here is a post where we talked a bit more about your options. I'd reach out to Julee if you have further questions https://www.biggerpockets.com/...
Hope this helps!
1 Reply
Janelle K. Eagle
Real Estate Agent · Central Coast, CA · Member since 2022 · 110 posts · 58 votes
4y
Hi @Eric Braxton - My wife and I used a 401k loan in order to make a 20% down payment on the purchase of our home. We borrowed about $40K and then were placed on a payment plan through her company to pay it back over time, something like $400 per month. We just recently decided to pay it all back after doing our taxes and making some money off a flip. Our CPA advised that the sooner we paid it back the better, as obviously the intention of a 401k is to have your money grow over time, and if you take money out, it's not growing! It was a nice SHORT TERM solution for us, but we only took the money out knowing that we had a strategy and the means to pay it back. Hope that helps!
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Eric BraxtonPro Member
OP
Garden City, NY · Member since 2021 · 19 posts · 5 votes
4y
@William Sing - I took a look at the link you posted but I dont think its the same topic. I could be missing something but I think you might be referring to the 203K which is differnt.
0 Reply
Eric BraxtonPro Member
OP
Garden City, NY · Member since 2021 · 19 posts · 5 votes
4y
@Janelle K. Eagle - so for your specific case there were no downsides unless of course you couple pay the 400 per month. In terms of the interest rate I read that it is based on the prime rate. Does that mean it was variable?
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Janelle K. Eagle
Real Estate Agent · Central Coast, CA · Member since 2022 · 110 posts · 58 votes
4y
Hi there, @Eric Braxton - which interest rate are you referring to?
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Eric BraxtonPro Member
OP
Garden City, NY · Member since 2021 · 19 posts · 5 votes
4y
@Janelle Eagle-Robles - the interest on the 401k loan. If I understand correctly there is an interest rate but it also goes back into the account. So it’s like you are paying yourself. Am I in left field on that?
0 Reply
Janelle K. Eagle
Real Estate Agent · Central Coast, CA · Member since 2022 · 110 posts · 58 votes
4y
@Eric Braxton not sure if you are in left field - but we did not pay any interest on the loan from our 401k - but we did it directly through my wife's company which she still works for and who provides the 401k. Other providers may charge interest? Not sure on that.
0 Reply
John Brodeur
Investor · Philadelphia Metro · Member since 2019 · 44 posts · 75 votes
4y
@Janelle Eagle-Robles, 401k loans are all required to charge interest per IRS and Erisa regulations. The unique thing about 401k loans is the interest charges goes directly into the individuals 401k and not to the plan provider.
Each employer has their own individual rules about what interest rate to charge, how many loans can be taken out at one time, duration etc. as long as the loans follow the overall irs guidelines.
OP, go to your HR or the company who administers the 401k plan and ask for their summary plan document. This is normally a 40 to 50 page document that has all the details about how your individual plan works.
https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-participant-loans-dont-conform-to-the-requirements-of-the-plan-document-and-irc-section-72p
1 Reply
Mike S.
Investor · Colonial Heights, VA · Member since 2014 · 115 posts · 68 votes
4y
I've done it before to fund some brrrr deals. After the property is refinanced pay it back. Easy peasy.
0 Reply
Greg PowersPro Member
Real Estate Agent · Manchester, NH · Member since 2013 · 120 posts · 159 votes
4y
@Eric Braxton, I used to work for a major plan provider and processed these loans all day long. They are VERY plan-specific, but they do have some great features:
1. As mentioned, there is an interest rate attached to them, but generally it is very low, and you pay the interest back to yourself into the plan.
2. There is no credit check required, and they are not reported to any credit agencies.
3. General loans usually have a 5-year term; some plans allow home loans which have a longer term (20 years?). General loans can be used for anything—downpayment, repairs, buying down an interest rate, car repairs, buying a new guitar…whatever you want.
4. Mortgage lenders do not count them against your debt-to-income ratio, so if you are using it as a downpayment for a mortgage it should not cause any problems on that front.
5. Some plans allow multiple loans either concurrently or sequentially (assuming you have enough in your account).
Downsides?
1. As mentioned, if you take the money out of your plan, it’s not working for you in the plan. But if you’re using it to buy a property with a better return than your retirement plan is getting, that’s actually an upside.
2. IRS limits you to borrowing $50,000 or 50% of your vested balance, whichever is less. Some plans are more restrictive.
3. If you stop paying it back, the loan will default. Many plans require them to be paid back via payroll deductions, so the only way to default on those is to leave your employer. However, if you do default, the unpaid balance becomes a distribution subject to ordinary income tax and possible a 10% early withdrawal penalty—but it will have no effect on your credit score or credit history since you just borrowed it from yourself. Defaulting May also have some plan-specific repercussions (some plans will restrict or eliminate your ability to borrow any more).
They can be a great tool if used correctly.
8 Reply
Janelle K. Eagle
Real Estate Agent · Central Coast, CA · Member since 2022 · 110 posts · 58 votes
4y
Super helpful and thorough! Thanks so much for sharing all your knowledge around this!!
0 Reply
Eric BraxtonPro Member
OP
Garden City, NY · Member since 2021 · 19 posts · 5 votes
4y
Agreed. Super helpful. Thanks to everyone.
0 Reply
Jonathan R McLaughlin
Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes
4y
@Eric Braxton I had--still have--a wonderful 401K plan from an old employer through Fidelity. Terms were great. 15 year am. for a primary residence which helped me buy our first condo. Prime + 3.25 which you pay to yourself. Other plans may have other rates but should be something like that. I believe the IRS sets the limit as half the 401K up to 50K.
Doesn't show up as debt so doesn't affect your ratios, if you don't pay it back it doesn't affect your credit, though you do get taxed plus the 10% withdrawl penalty.
Did it again for help with a rental property and it worked out well, this time it was a 5 year amortization which was a little rough but a refi took care of paying that back. We also used it as an emergency fund. We do have other retirement mechanisms, including a pension, so felt we could be a little more aggressive. Big Fan.
Depending on the plan, you might have to pay back the loan immediately if you change jobs, which in my mind is a big negative. Wasn't true for ours though we kept it going. I think I covered most of it, but happy to talk direct if you PM
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Jonathan R McLaughlin
Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes
4y
Our loan was set at prime when we took it out plus 3.25 and wasn't variable. Not sure if thats every plan

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Loki Rao
Raleigh, NC · Member since 2019 · 17 posts · 6 votes
4y
@Eric Braxton all of the info provided is useful. I would like to add one more point which no one mentioned to my surprise.
Whenever you are taking the 401k loan really matters as 401K is not going to hold any cash positions. Whenever your loan is processed your provider will liquidate etf/fund holdings at that time. Current stock market is already 30 to 50% down( obviously depends on your current holdings). Who knows how the market may perform in future until you pay off the loan. It is a bit tricky to know how much percentage growth you might be loosing with 401K loans. Due to this reason I personally take 401K loans if the loan duration is really small just to avoid timing the stock market.
0 Reply
Joseph Hammel
Rental Property Investor · Lake Hallie, WI · Member since 2015 · 292 posts · 144 votes
4y
Make sure you know the rules if you leave the company. Some will let you keep the same payback plan. Some require it to be paid back in full or you take it as a taxable distribution. So if you had a job change in the future or who knows what else could happen you would want a backup plan for the second option.
1 Reply
Paul Camuto
Real Estate Coach · Robbinsville, NJ · Member since 2017 · 185 posts · 99 votes
4y
Quote from @Eric Braxton:

I am thinking about using a 401(k) loan to fund a property. I’ve read up on some of the risks involved. Looking for anyone with some real world experience to share some advice on what to do/not to do that you think would be helpful for others to know.
I haven’t spoken to my plan admin yet but want to come prepared with some additional knowledge if possible.
Thanks.

Why do you need a 401K loan? No other savings? Lower your 401K contributions and save toward getting a home. Keep retirement assets and real estate rentals separate.
0 Reply
Eric BraxtonPro Member
OP
Garden City, NY · Member since 2021 · 19 posts · 5 votes
4y
@Paul Camuto - nice segue into my follow-on question. I was getting educated on my options when I came across the 401(k) option as something that is more attractive in a down market since you may be paying yourself more interest than the 401(k) would be returning. Not saying that I have checked out all of the number but wanted to get some opinions on it. Yes, I have savings and also a HELOC. I agree using savings is more cost effective (pay no interest and no lost 401(k) gains).
What about HELOC vs 401(k) Loan? For those of you who have done the 401(k) why did you chose that over a HELOC? A fixed rate vs a variable would be more attractive right now with rates going up but my HELOC also has access to a much bigger amount. Note that I would plan to buy cash and refinance to pay either one back as quickly as possible.
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Joseph Hammel
Rental Property Investor · Lake Hallie, WI · Member since 2015 · 292 posts · 144 votes
4y
Quote from @Paul Camuto:

Quote from @Eric Braxton:

I am thinking about using a 401(k) loan to fund a property. I’ve read up on some of the risks involved. Looking for anyone with some real world experience to share some advice on what to do/not to do that you think would be helpful for others to know.
I haven’t spoken to my plan admin yet but want to come prepared with some additional knowledge if possible.
Thanks.

Why do you need a 401K loan? No other savings? Lower your 401K contributions and save toward getting a home. Keep retirement assets and real estate rentals separate.

If that's what you got to get you in the game why not? I bought my first investment property a duplex 10 years ago for 30k.
14k came from refinance on my house 6K was on credit card checks and the balance was a 401k loan that got me in the door and I haven't looked back. At that time I immediately refinanced the 30k property on a first position HELOC and took 80k out of it. 10 years later I just closed on a handful of units and went over the 100 unit mark at 105. I'm going on 5 years since I've had a W-2 job real estate has been good.

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Basit SiddiqiBusiness Member
Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
4y
@Eric Braxton

The risk is if decide to leave the job or you get let go, you will be required to pay back the loan. If you do not pay back the loan, the loan amount will be considered a distribution and added to taxable income + subject to a 10% penalty if below 59.5.

Best of luck.
[email protected]917-280-8544
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Joseph Hammel
Rental Property Investor · Lake Hallie, WI · Member since 2015 · 292 posts · 144 votes
4y
Quote from @Basit Siddiqi:

@Eric Braxton

The risk is if decide to leave the job or you get let go, you will be required to pay back the loan. If you do not pay back the loan, the loan amount will be considered a distribution and added to taxable income + subject to a 10% penalty if below 59.5.

Best of luck.

That depends on the plan rules.
when I left my job I was able to keep making the same payments.
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