Borrow from 401k for down payment

[Nick Weidner]

I was looking to barrow $25K from my 401K.   Talking with a co-worker our 401K allows us to borrow up to 50% up to a certain dollar limit at 4.45%.     I was going to pull the $25K over 36 months paying $371 bi-monthly.

In Texas am I allowed to borrow against my 401K to use the money as a down payment for a rental property?     This would be for my second rental property.

[Brian Eastman]

@Nick Weidner 

Whether a lender will be OK with the down payment coming from a 401(k)  will depend largely on their overall underwriting.  I do not believe there is a state law component, but there could be, so check with your lender.

A lot of folks here on BP tout the idea of a 401(K) loan for a property purchase.  The thing that is missed by most is the fact that the $25K loan will likely cost you in about $35K.  Is that worth it to you?

The issue is that while you do not pay taxes or penalties on the borrowed funds, you are replacing the pre-tax dollars in the plan with after-tax dollars out of your pocket.  In addition to the interest on the loan (which does go to the plan), you are effectively paying whatever your marginal tax rate is on top.  So, if your tax rate is 28%, that $25K will cost you $35K in new earnings to replace.

My firm markets Solo 401K plans that offer a participant loan. Some of our investors choose to use that loan provision.  But, we are always sure to point out this key fact about the true cost of that money. It is the right thing to do.