Using 401k vs. HELOC vs. Home Equity loan for STR Down Payment

[Kathy Leach]

Hello. I am new to real estate investing planning to buy my first STR in 2023, I am saving for cash down payment but wondering if taking a loan from my 401k would be a way for me to make this purchase sooner if the right property came along? Or would using home equity loan or HELOC from my primary residence be the better way to come up with the additional cash needed? Thanks for any feedback. Trying to overcome fear as a newbie to investing and remove roadblocks to jump into this, I anticipate getting past the first purchase is the hardest part.

[Mark S.]

@Kathy Leach, great question and lots to consider.  I am following this thread to see others’ thoughts as well.  This is not tax advice, just some dude on the internet’s opinion.

With the 401(k) loan, you’d likely be looking at a general purpose loan where the max repayment is 5 years.  Most plans will have a fixed interest rate.  If things get tight, you still have to make the loan payment; otherwise, the outstanding balance would generally be taxable and if you’re under 59.5, also generally subject to the 10% IRS early withdrawal penalty.  Some plans will allow you to continue contributing while making repayments while others may not (for a period of time, usually much less than the loan repayment period of 5 years).  Another consideration is if you are suddenly no longer employed with that organization - many plans will require the loan to be repaid in full shortly thereafter; others may allow you to continue making payments.  Make sure you understand the rules of your plan.  

With the HELOC option, many HELOCs have a 10-year interest only period followed by a 20-year principal and interest repayment period. Most HELOCs will have a variable interest rate, however, some also offer a lock-in feature to convert it to a fixed rate on a specific, outstanding sum (subject to some minimum amount). The fixed lock-in is usually slightly higher than the current variable rate.

For example: Let's say you have $50K outstanding at a variable rate during the interest only period. Some HELOCs may allow you to "lock-in" that $50K at a fixed rate 0.50% higher than the current variable rate. This might make sense if you believe rates will continue to rise. You want to learn the specifics of the HELOC you're considering - things like interest only period & repayment period, any fixed "lock-in" options and corresponding restrictions, closing costs (if any) to get the HELOC - some credit unions offer $0 closing cost promos if the initial draw amount meets a certain minimum, any annual fees/maintenance fees, etc.

Step 1 in my opinion is gather information and map it out.  This is crucial before thinking through the rest of the decision.  

Remember that a HELOC has your home as collateral. If you default, you lose your home. With the 401(k) loan, your house isn't at risk, but the loan terms can be more stringent and possible acceleration reasons can introduce some risk as well. Lots to think about, but hopefully this is enough to get you started.