Rental, turn negative cash flow positive with 401k loan?

Question

Hi.

I have a 1950s SFH property purchased back in 2005 for $178k. Zip code 98310. Population growth, total about 5% during the last 10 years. It has a detached two car garage. Decent sized land. Unfinished full height basement. Basement accessible from outside stairs. Its price went up a little bit during real estate bubble years. In 2009, I refinanced the property from 5.6% to 4.9% interest rate. I moved to another city due to job and rented the property out because I did not want to sell at a loss. Cash flow wise, it costs me $120 a month. Which I can handle OK. Now it's 2014. I am guessing it's worth $140k. I owe $125k with 25 years to go on the mortgage. Not able to refinance to lower interest rate because LTV is 75% with traditional lender.

Since it's about 2 hours drive away. Property management company is taking care of the property. Property management fee is 10%.

I would like to explore some options with this property:
1. Sell at a loss and become cash flow neutral?
2. Borrow from my own 401k retirement account and pay down the principle. The 401k loan will need to be paid back during the next 15 years at 2.4% interest. The 401k loan interest goes back to my own account. Basically I am my own bank. Doing this would turn negative cash flow to positive cash flow of $90 per month. Is this a good option? Or is this good money chasing after bad money?
3. Borrow from 401k retirement account and acquire another cash flow positive property to cover the original cash flow negative property?
4. Finish the basement and then rent or sell?

What would you do in this situation?

Do you consider paying down mortgage and gaining equity as part of the total ROI? How does one calculate that?

Dmitriy Fomichenko · Answer

@Steve Kuan

The loans from 401k are typically for 5 years and the maximum amount you can borrow is $50K. Not sure if that would help you since your mortgage balance is significantly higher.

In my opinion it's not a good idea to borrow from your 401k for this reason. I like the idea however of finishing the basement and renting it out for additional income since it has separate entrance.

Mark Cypher · Answer

I like the idea of borrowing from your 401K to reduce the loan to get under the 75% LTV so you can refinance at a better overall rate. I have done it twice to buy and refinance and am very happy with the results.

Look at it from two perspectives: The owner of the 401K and the one borrowing money.

1. As owner of the 401K you can consider this to be a non-volatile bond which pays at a rate of 2.4%. A balanced 401K is advised. You are giving up a high return for a consistent rate.

2. As a borrower you are paying 2.5% less, lowering your overall payment responsibility. The money you do pay goes back to you and not the bank.

The Double tax argument: You don't get taxed on your loan, but get taxed twice on the repayment. It's a wash.

Note: Don't reduce your current 401k contributions just because you are putting this money in. This should be in additional to the current rate.

Brant Richardson · Answer

2 hours away is not too far away to manage it yourself. I would not want to manage a whole portfolio two hours away but one property is doable. Do a really good job screening a tenant and manage it yourself, at that point you will probably be cash flow neutral.

If you have cash flow positive opportunities where you live now I would seriously consider selling at a loss. It's a painful mental hurdle but if you can get out of negative cash flow to get into positive cash flow then you need to get over it.

With high interest debt, like 18% credit card debt, borrowing against your 401k is a no brainer. With a 4.9% loan its not so compelling.

Bryce Till · Answer

Remember that retirement accounts cannot be touched my creditors. If you really get in a bind these accounts will be the only thing safe.

Also, to pay back the loan your using after tax dollars and then that same dollar will get taxed again when you take distributions.

I like the idea of finding another property to cover the difference. Make some life style changes to contribute a few extra hundred dollars a month toward the principal. You're 5 years into your amortization which is worth something. You'd have to find a great deal to make up for it, but, isn't that why were all here?

Ryan R. · Answer

First, you need to have a really good estimate of what the house is worth. Second, you need to have a really good estimate of how much it would cost to finish the basement and then how much monthly rent that would generate.

Once you have those numbers, it'll make your decision much easier.

Scott E. · Answer

I don't like long term loans on 401k's. You have to consider the return lost. Yes, you are borrowing from yourself and paying yourself back at a low rate, but that big chunk of money is no longer performing for you in your 401k.

If you take $50k that is earning you say 8% in your 401k and move that money to pay down the principle balance on your 4.9% tax deductible mortgage you're not putting the money to good use.

Rental, turn negative cash flow positive with 401k loan?

Rental, turn negative cash flow positive with 401k loan?

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