Which way should I go... 401K or HELOC?

Question

I'm currently trying to decide on if I should borrow money from my 401K or use a HELOC. Please share you thoughts!

Let
 say that I'm able to use my 401K to borrow $30K. The other alternative 
would be for me to transfer my current rental property into my 2 month 
old LLC which I want to do anyway, and obtain a HELOC with the equity I 
have in it. Let's also assume that this will give me a HELOC at $30K. 
Which option would be best in your opinion? I'm planning to use the 
money to BRRRR. This will be on OTC tax deed and my second rental 
property.

Jaysen Medhurst · Answer

@John H. Hill Jr., I say HELOC all day long. You pay next to nothing until you actually use the money and only pay interest on the money being used.

Nicole Hoss · Answer

@John H. Hill Jr. Lots of good thought on here for you to take into consideration! I used a HELOC on my primary residence to pay "cash" on my OOS TK investments in order to pay the lowest price (I found that financing deals up front means I pay more for the property). After taking possession of the property with a tenant in place, I then did a cash out refi on each property to essentially "pay back" my HELOC. Now I have conventional loans on my properties and use my HELOC to buy more properties! It works for us and I'd be happy to discuss further if you'd like. Just DM me!

Albert Bui · Answer

The advantages of the 401k loan is that its generally not counted against your DTI ratios since you're borrowing against your own financial asset. This might be important if you're looking to manage your DTI or debt to income so you can keep your purchasing power open for any deals coming to your desk in the future.

You're only limited to 50k or 50% whichever is lower with your 401k anyway.

The HELOC on the other hand will cause your monthly payment whether interest only or principal & interest to go up which will increase your DTI and leave less room for future qualification depending on the deals you purchase with these funds.

From a credit perspective, having the HELOC might be better because now you have an additional trade line reporting good payment ratings to the credit bureaus assuming you pay your bills on time.

Ultimately, its good to use a fine balance of all sources based on your risk preferences, speed of execution or purchase, financial position today, and your deals you have access to to get this capital to work on your behalf.

Hope that helps.

Kevin S. · Answer

@John H. Hill Jr. I can't speak to the HELOC side, but I can speak about the 401k. First off, if you haven't already, please make sure to verify your 401k plan allows loans. Some plans do, some don't.

To me, the upside of using your 401k is that any interest you pay on the loan, you pay to yourself versus paying it to a bank for a HELOC.

However unless it's being used to purchase a principal residence (which this does not sound like) then the time limit on the loans is limited to a 5 year loan (10 years if it's a principal residence). Additionally, you are only allowed to withdraw up to whatever your plan limits the loan to, but most often this is the lesser of 50% of your vested balance OR $50k. Some plans also limit the type of money you can take a loan on, so you may be able to take a loan on money you've contributed, but not on Employer Match money.

Overall it can be a good option, but there are definitely things to consider and check out. Good luck!

Jaysen Medhurst · Answer

@John H. Hill Jr. and @Cassandra Sifford, both Pen Fed Credit Union and Figure do HELOCs on investment properties. 1-4 family, 75-80% LTV.

Cassandra is correct that the interest you pay on a 401(k) loan goes back to your retirement account.

Erik W. · Answer

@John H. Hill Jr., I wouldn't do either.  As others have said most banks won't do a HELOC on a rental.  Some will, but you're limited to probably no more than 60% LTV including existing financing.  And I would never put a HELOC on my personal residence: risking the family home on a roll of the dice rehabbing a property for investment is dangerous, especially since in many areas we're hitting record pricing again.  If the market falls, you can't refi and pay off your HELOC, which puts your home at risk.

The BRRRR strategy depends on you having a large amount of equity in a property.  Let's say for example you purchased a property for $50,000 cash and renovated it for $10,000 cash (i.e. no debt in the picture) and the value is now $80,000.   You can then refinance at 80% LTV and "pull out" the $60,000 combined purchase price and rehab and go do the same thing again, and again, and again.  Actually, you could go up to $64,000...($80K * 80%), but you get the idea.

If you did the same thing but used debt for the purchase and rehab, then you would owe $60,000 already on a property worth $80,000, and it is unlikely anyone will lend against that slim margin.

Another strategy for raising cash is equity partners.  Find some doctors, lawyers, small business owners, or dear old Aunt Tilly who have a couple hundred thousand parked in CDs, money markets, or savings accounts earning diddly squat in interest.  Offer them a piece of the monthly rent and/or equity in exchange for funding your deals.

Cassandra Sifford · Answer

@John H. Hill Jr.  I'm not an expert on the topic, but figured I'd give my lil $0.02 ...  I want to say that I've read numerous times that you cannot get a HELoC on an investment property and only on your primary residence.  If they do allow it, you won't be able to borrow as much as if it were your primary residence. If you're using funds from your 401k, how long will it take you to pay it back?  Will the interest charged be worth it during the loan payback time frame?

John H. Hill Jr. · Answer

@Nicole Hoss

That is my ideal approach. I would love to here more on what your experiences have been Nicole.

John H. Hill Jr. · Answer

@Albert Bui

Powerful stuff there sir... thank you! You hit several key things that are important to me. DTI is something that I hadn't thought about. Being that I'm trying to break into building my business credit so that I can have not only HELOCs, but lines of credit in general, I would like to come to the table having as little debt as possible against my business. However, I know that using a HELOC as a credit line is also important. Maybe even more important because that's a way to build the credit up in the first place. That may main reason to go with a HELOC if I can get one with my rental property over using my 401K in my situation all things considered.

Which brings us to the idea of "both". I might just do that. Use the HELOC as a means to assist building business credit, while combining funds from my 401K to keep my DTI low and insure that my HELOC does not exceed 30% of my limit to keep my score optimal.

John H. Hill Jr. · Answer

@Kevin S.

Yes my 401K does allow it. I believe it's also true that the money can be used for what ever I want to use it for, but will have to check to see what the specifics are on the loan terms. My plan is to pay the money back in under a year either way. I'm beginning to see that overall the best choice in my situation is going with the 401K. The only downside sounds like I'll miss out on any gains during the time that money is not in my account. Thank you sir for the feedback.

Which way should I go... 401K or HELOC?

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