Rental Property Investor · Chicago, IL · Member since 2018 · 22 posts · 12 votes
I'd like to purchase a 2 unit building with a 203k loan that I'll eventually BRRR. I have some money in savings, but not enough to cover a down payment, closing costs, and reserves to hold me over for a few moths while I manage the construction and vacancy.
I'm considering asking my parents to withdraw $10k from their 401k. This will be used for a down payment and closing costs while my personal savings will sit in reserves. I've never asked my parents for money, so I'd like to approach them with a simple strategy. I'll show them the numbers, how the property cash flows and the plan to cashout refi to repay them the loan plus the 10% withdraw penalty.
I understand all investments involve risk, but how can I protect their investment from any loss? Lets say the whole deal tanks. How can they recover their $11k?
Developer · Chicago IL · Member since 2019 · 147 posts · 125 votes
7y
Kristina,
First off I’d like to shake your hand and give you a big hug for sincerely trying to protect your parents investment! You are a wonderful woman. Second I’d like to shake your hand for having all of the numbers to provide a positive cash flow.
Now that I’ve gotten all of the good vibes going, there really is no way to protect your parents investment should the whole project tank. I did have a similar situation and the bottom line is at the end of the day if the property is worth less than all of the loans there is no way to recoup the money invested. This becomes especially hard with Family.
I would advise when you present your calculations you also have a heart to heart about the reality of what an investment is. I received some very wise advice quite some time ago and I know it is very relevant here; do not invest money you cannot afford to lose. If losing the money you are investing is going to change the quality of your life, don’t do it.
Developer · Chicago IL · Member since 2019 · 147 posts · 125 votes
7y
Kristina,
First off I’d like to shake your hand and give you a big hug for sincerely trying to protect your parents investment! You are a wonderful woman. Second I’d like to shake your hand for having all of the numbers to provide a positive cash flow.
Now that I’ve gotten all of the good vibes going, there really is no way to protect your parents investment should the whole project tank. I did have a similar situation and the bottom line is at the end of the day if the property is worth less than all of the loans there is no way to recoup the money invested. This becomes especially hard with Family.
I would advise when you present your calculations you also have a heart to heart about the reality of what an investment is. I received some very wise advice quite some time ago and I know it is very relevant here; do not invest money you cannot afford to lose. If losing the money you are investing is going to change the quality of your life, don’t do it.
Investor · Chattanooga, TN · Member since 2013 · 53 posts · 24 votes
7y
I agree with Sue Hough that your should be applauded for being so considerate of your parents money! Here is my advice, consider a hard money loan and all that involves if you really believe you have a good deal. If that scares you, don't borrow that money from your parents. Nothing wrong with borrowing money from a family member or friend as long as long as everyone involved understands its an investment with no guaranties. Be conservative on your analysis and plan your exit strategies. Just my .02!
Specialist · San Antonio, TX · Member since 2015 · 909 posts · 297 votes
7y
there are other loan products, i wouldnt do HML unless absolutely necessary, there are a lot of options for you and no actually your parents wouldnt lose money.. the property will be properly insured, im sure your buying it right so there investment is offset at second position, and you are in chicago, it can only appreciate if you are in the right neighborhood
Rental Property Investor · Los Angeles, CA · Member since 2016 · 172 posts · 122 votes
7y
@Kristina Lugo Great questions Kristina! First off be aware that even if your parents let you borrow the money, you should have the money "seasoned" in a bank account 2 months prior. Lenders will not be happy to see that you do not have a down payment and that you recently deposited that money in the bank. They will deny your application.
First thing I would say is that on most 401K plans you can take out a loan. It is usually 50%. I would call their 401k provider and find out. I took out a loan on my 401K and I had 10 years to pay it back. The interest goes back on your 401k from what I understand.
Second thing I would say is that you need to have an IRA. With an IRA you can 10k tax free to purchase a primary residence. PLUS Uncle Sam won't tax that amount.
I am not a tax advisor so please check online to get the right info. Good luck!
Your parents would have to confirm that their plan allows for a 401k participant loan (and that they have not had an outstanding loan in the last 12 months).
If yes, they can borrow up to 50% of the balance not to exceed $50,000.
The repayment terms are equal monthly/quarterly payments (as you prefer) of principal and interest (e.g. prime + 1%) spread over a 5 year term (or longer if you will use the loan to purchase your primary residence). There are no prepayment penalties and no restrictions on what you can do with the proceeds of the 401k loan. Please note that your parents are obligated to pay back their 401k (even if you are paying your parents back).
Per the loan offset rules that went into effect with the 2018 Tax and Job Act: if your parent leaves his/her job and the loan is current at the time your parent leaves his/her job but then the loan goes into default because your parent left his/her job, your parent will have until his/her tax return deadline (including any timely filed extension) to make the loan current by depositing the outstanding balance into an IRA (and thereby avoid the taxes and penalties that would otherwise apply).
If the parent that is taking the distribution is at least age 59.5, they should not have an early distribution penalty of 10%. This might help.
If there is a participant loan feature on the plan, they could potentially access the funds without any taxes or penalties, but should consider any loss from those funds not being invested in the plan.
As far as protecting their loss in the event that the deal tanks, they could get a promissory note from you, but then you would be liable for coming up with the funds.
Rental Property Investor · Chicago, IL · Member since 2018 · 22 posts · 12 votes
7y
@Justin Kane thanks, Justin. The neighborhood is changing with investors coming in and creating a lot of value. Properties are being flipped quickly! My strategy is buy and hold but seeing the gains other investors are experiencing is a good sign!
Rental Property Investor · Chicago, IL · Member since 2018 · 22 posts · 12 votes
7y
@Justin Windham they’re 57 so not quite there but my moms ready to take an early retirement and has mentioned real estate investing. I’d like to come in as the deal maker so they can be hands off. I think 10k to start them as investors with me is a good way to get that goin for them.
Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
7y
@Kristina Lugo. It’s admirable you want to protect your parents money but the best way to do that is to not use it. You can’t just take 10k from a 401k and then “but it back”. They’ll pay taxes on that and the ten percent fee, which means if you pay them all that back plus interest (say 7-8 Percent) the cost to is a lot more then 10k.
Borrowing will also be tricky as your parents will have to sign something which says it’s a gift, which you just admitted it’s not. Which means you’re probably committing mortgage fraud if you don’t disclose this to your bank.
So long story short the actual best solution to protect your parents money is not use it at all.
Rental Property Investor · Chicago, IL · Member since 2018 · 22 posts · 12 votes
7y
@Caleb Heimsoth
Hey Caleb, thanks for the advice. I was thinking after paying them back the $10k they would keep it in an account and they can use it for future investments with me or others that would bring them greater returns than the 401k.
Hey Caleb, thanks for the advice. I was thinking after paying them back the $10k they would keep it in an account and they can use it for future investments with me or others that would bring them greater returns than the 401k.
Its probably unlikely that this gives greater returns then the 401k, but let’s put that issue aside for a minute.
If I assume your parents are in the middle tax bracket of 24 percent. If they withdraw 10k they’ll pay 2400 in taxes and another 1000 in early penalty. So they actually need to withdraw closer to 15k to actually net 10k after taxes and penalty.
Then because you’re you don’t want to take advantage of your parents you’ll pay them the 8 percent (over a year) thay they didn’t earn on that money staying invested, which means roughly speaking to borrow 10k from them (the right way) you would then pay them back 16k. That seems like expensive money to me.
@George Blower It seems pulling out the 10k and paying penalty and fed tax would be easier?
Assuming that they are eligible to take a distribution from their current employer plan (they would need to confirm with the administrator), this might be another option to consider.
Rental Property Investor · Chicago, IL · Member since 2018 · 22 posts · 12 votes
7y
@Caleb Heimsoth
Got it, these are the numbers I need to better understand by talking to a professional. I appreciate your responsiveness as it prepares me to have that convo!
Got it, these are the numbers I need to better understand by talking to a professional. I appreciate your responsiveness as it prepares me to have that convo!
I’m glad I could help but my main point was don’t have this conversation with your parents at all, at least at this time.
Rental Property Investor · Orlando, FL · Member since 2018 · 301 posts · 354 votes
7y
@Kristina Lugo I have not read all the responses so I apologize if someone has already suggested this, but rather then barrow $10k from you parents while leaving your $ in reserves, use your money with an agreement with them that “if” you need the money then they are open to it. Just a though.
Rental Property Investor · Central, FL · Member since 2016 · 950 posts · 821 votes
7y
Congrats on taking the first step.
First, what’s the actual numbers for this 2 unit that you are talking about?
Do your parents have 10,000 in something other then their 401k? By 57 typically there are other assets not just the 401k. Might be worth the conversation
Realtor · Boulder, CO · Member since 2016 · 3k+ posts · 5k+ votes
7y
@Kristina Lugo Couple red flags here: for starters lenders don't like to see borrowed money used for a down payment so it's unlikely you'd qualify for financing that way. A potential solution there would be to ask your parents to co-sign on the loan. The best place to start would be to sit down with a mortgage broker and discuss what you qualify for (if you haven't already). Generally speaking if you need to borrow $10k for a down payment, you're likely undercapitalized. As far as the rehab budget goes you should figure all your expenses down to the penny and then double it. Be prepared for major overruns on cost and timeline as that's just the way these things go. Do you need to do several months of work to get the rent you need to cash flow? Some light rehab might be a safer option for a first project even if it means less cash flow. You'll want to look at every way possible to limit your risk. Also if you're planning to BRRR, be sure to budget for double closing costs plus factor in the higher payments after you refinance. It's quite rare to find a deal where refinancing within the first few years actually makes sense. You really need to have a very sweet purchase price and also be super dialed in on the rehab side to make BRRR work. What are the numbers on the deal? What class is the property? Do you have a great team of tradespeople in place or are you skilled in doing the work yourself? What are your total cash reserves separate from the rehab budget? Just some things to think about! Real estate is a lot more capital intensive than most people realize. Buying the property isn't always where you spend the bulk of your money, it's the ownership part that can get expensive (at least until you get the property fixed up and stabilized which can take a year or more of losing money). So if you're needing to borrow $10k for the down payment that's not a good start which is why lenders don't let that fly. But if the deal is good enough the money will come, so how good is the deal?
Rental Property Investor · Brooklyn NY · Member since 2018 · 263 posts · 469 votes
7y
I would wait until you have enough capital. If you just have to borrow money from your parents, I'd suggest asking them for cash they are willing to invest. Make sure they understand the risks.