401(k) Loans to Finance Rental

[Eric Braxton]

I am thinking about using a 401(k) loan to fund a property. I’ve read up on some of the risks involved. Looking for anyone with some real world experience to share some advice on what to do/not to do that you think would be helpful for others to know.

I haven’t spoken to my plan admin yet but want to come prepared with some additional knowledge if possible.

Thanks.

[Greg Powers]

@Eric Braxton, I used to work for a major plan provider and processed these loans all day long. They are VERY plan-specific, but they do have some great features:

1. As mentioned, there is an interest rate attached to them, but generally it is very low, and you pay the interest back to yourself into the plan.

2. There is no credit check required, and they are not reported to any credit agencies.

3. General loans usually have a 5-year term; some plans allow home loans which have a longer term (20 years?). General loans can be used for anything—downpayment, repairs, buying down an interest rate, car repairs, buying a new guitar…whatever you want.

4. Mortgage lenders do not count them against your debt-to-income ratio, so if you are using it as a downpayment for a mortgage it should not cause any problems on that front.

5. Some plans allow multiple loans either concurrently or sequentially (assuming you have enough in your account).

Downsides?

1. As mentioned, if you take the money out of your plan, it’s not working for you in the plan. But if you’re using it to buy a property with a better return than your retirement plan is getting, that’s actually an upside.

2. IRS limits you to borrowing $50,000 or 50% of your vested balance, whichever is less. Some plans are more restrictive.

3. If you stop paying it back, the loan will default. Many plans require them to be paid back via payroll deductions, so the only way to default on those is to leave your employer. However, if you do default, the unpaid balance becomes a distribution subject to ordinary income tax and possible a 10% early withdrawal penalty—but it will have no effect on your credit score or credit history since you just borrowed it from yourself. Defaulting May also have some plan-specific repercussions (some plans will restrict or eliminate your ability to borrow any more).

They can be a great tool if used correctly.