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Investing in Income Property with Your 401K

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If you are considering getting into rental property investing, you might be struggling to come up with the down payment on your mortgage.  There are multiple ways to fund the down payment without taking money directly out of your pocket.  For example, you could get a HELOC on your primary residence, try and get an 80/20 loan, borrow from friends and family, or secure the funds from your 401K.  While all of these options clearly have pros and cons, the purpose of today’s post is to drill down into 401K investing specifically.

The process is basically to take a loan from your 401K, which means you will pay yourself back every month with interest.  The interest rule of thumb is typically 1-2 % above the prime rate, and the term of the loan can usually be anywhere from 5-10 years.  Note that this differs from simply doing an early 401K withdrawal, which will come with a 10% penalty.  Also note that this is different from using a self-directed IRA to fund an acquisition.  I will write about that in the future but for now it is beyond the scope of this article.

Obviously the main advantage of getting a 401K loan is that you can literally buy income property with no money out of pocket.  You can use your 401K loan to fund the down payment, closing costs, and even rehab costs in the case of a fixer upper. 

As you might imagine, there are also drawbacks to this technique.  First, if you take the loan and lose your job before refinancing, you will only have 60 days to repay it to avoid incurring the dreaded 10% penalty and related fees.  Second, if you are unable to hit your target numbers when refinancing, you may not be able to get enough cash out of the equity to pay off the 401K loan, which again could expose you to the 10% penalty and additional late fees.

In the final analysis, this strategy is least risky with a fixer upper or some other below-market property that can be fixed up and refinanced relatively quickly so you can pay back the 401K loan ASAP.  In most other circumstances, this technique seems too risky.  The bottom line is to always discuss your plans with an accountant or some other knowledgeable professional who can offer guidance for your specific situation.

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