Better to borrow from Bank or 401k?

[DAVID GAGE]

Looking to borrow about $20k to help with the purchase of another rental property. I have the ability to refi one of my houses or I could borrow from my 401k. Not sure of all the details about the 401k loan, I do know its 7% interest and 5 years to be payed in full but other than that I haven't really researched it much. Hadn't really considered it before now so I guess what I'm wondering is what would you guys do assuming i get the same 7% from a bank.

[David Beard]

With the 401-K, you are not really borrowing. The plan will simply cash you out of $20k of investments that you currently hold in the plan. They will determine the payment to amortize it over 5 years at the 7% rate, and you pay the so-called "interest" back to yourself. By paying it back as agreed, you will avoid taxes and early withdrawal penalties. If you leave your employment, it may be due immediately in order to avoid said taxes and penalties. You will need to investigate this. Obviously it will be hard to make the house cash flow using a 5 year amortizing loan. But if you don't need the cash flow, and you're getting a great deal, then I think it's a good alternative use of your 401-k funds. Most plans have limits on how many of these loans you can have in total, and how many you can do in a 12 month period. This payment on your 401-K loan will also not be considered an obligation for purposes of debt ratios (since you're paying yourself and if you stop doing so it only triggers taxes and early withdrawal penalties).

You could also refinance the other property you own and use the funds to pick up another great deal in this buyers market.