Poll

Would you take out a 401k loan to help finance a flip?

Yes
3 (15%)
No
12 (60%)
Depends on how good of a deal the property is
5 (25%)

Total Members Voted: 20

Author Topic: Would you take out a 401k loan to help finance a flip?  (Read 3683 times)

FIreDrill

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Would you take out a 401k loan to help finance a flip?
« on: January 03, 2017, 03:15:55 PM »
I have been really interested in real estate investing for several years now.  I've read multiple books and lurked on different blogs/forums (mostly biggerpockets).The market I live in seems to be pretty unique and I don't see rental properties being worth my time.  You would be hard pressed to find a home that meets the 2% rule in my area.With rental properties out of the question, I've been watching distressed homes for possible flips over the last 2 years or so and in that time I have seen maybe 2-3 that would meet the 70% ARV - Repairs rule.

It's gotten to the point that I would like to jump in and attempt to make some money off a flip in the next year or so, and continue flipping on the side if it ends up being profitable. I have started laying out various steps that I need to take in order to peruse this.  I have an agent to work with but still need to find a good General Contractor.  My main concern is financing.  I have talked to a mortgage broker that specializes in rehab loans and said he can finance up to 85% of the purchase + repairs needed.  At the price point we are targeting, we would need about 37-45k down for purchase/closing.

This is where it gets a little interesting.  We have been "good" mustachians the last several years which means we have a sizable amount of money put away.  The issue is the majority of our money is stocked in taxed advantages accounts (401k's, IRA's, HSA's) that we cannot access easily for flipping. However, recently I started looking into 401k loans to possible finance part of the flip and what I found was pretty interesting.  Below is a quick look at my companies 401k loan structure.


Loan amount               = 50,000 or 50% of 401k balance, whichever is less.
Interest rate                     = 4.75% (both principle and interest payments are paid directly into your 401k account)
Fees                   = 181.25 (5 year loan with 50.00 set up fee and 6.25 quarterly maintenance fee)
Contribution restrictions    = None (You can continue to contribute and receive matches while making 401k loan payments)
Gotch ya's               = Miss out on returns. If you leave your company, 100% of the outstanding balance is due.
Bi-Monthly Payment         = 468.52


Brief summary of our current financial status.

Non tax sheltered savings    = 21,000 (Money we could use towards a flip)
Tax Sheltered Investments   = 203,000
Home Equity/Other         = 55,000

Total Net Worth            = 278,000


Current gross income = 120-130k/yr (Before taxes, insurance, HSA contributions, and two 401k account contributions.)

Our current savings rate is around 60-70% which allows us to max our 401k's, HSA's, and IRA's.  Our high savings rate does give us flexibility in our budget.  If things went wrong we could easily cash-flow the 401k loan repayment.  Obviously there are risks involved but the 401k loan is starting to look like a pretty good deal for accessing tax sheltered investments for short term non tax sheltered investing (House Flipping).

I would love to know your thoughts on this situation and if you would take advantage of the 401k loan.  Please point out any disadvantages that I am missing.

Also, we are in our mid 20's if that helps anyone...

Thanks in advance!

radram

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #1 on: January 03, 2017, 03:44:13 PM »
I have been really interested in real estate investing for several years now.  I've read multiple books and lurked on different blogs/forums (mostly biggerpockets).The market I live in seems to be pretty unique and I don't see rental properties being worth my time.  You would be hard pressed to find a home that meets the 2% rule in my area.With rental properties out of the question, I've been watching distressed homes for possible flips over the last 2 years or so and in that time I have seen maybe 2-3 that would meet the 70% ARV - Repairs rule.

It's gotten to the point that I would like to jump in and attempt to make some money off a flip in the next year or so, and continue flipping on the side if it ends up being profitable. I have started laying out various steps that I need to take in order to peruse this.  I have an agent to work with but still need to find a good General Contractor.  My main concern is financing.  I have talked to a mortgage broker that specializes in rehab loans and said he can finance up to 85% of the purchase + repairs needed.  At the price point we are targeting, we would need about 37-45k down for purchase/closing.

This is where it gets a little interesting.  We have been "good" mustachians the last several years which means we have a sizable amount of money put away.  The issue is the majority of our money is stocked in taxed advantages accounts (401k's, IRA's, HSA's) that we cannot access easily for flipping. However, recently I started looking into 401k loans to possible finance part of the flip and what I found was pretty interesting.  Below is a quick look at my companies 401k loan structure.


Loan amount               = 50,000 or 50% of 401k balance, whichever is less.
Interest rate                     = 4.75% (both principle and interest payments are paid directly into your 401k account)
Fees                   = 181.25 (5 year loan with 50.00 set up fee and 6.25 quarterly maintenance fee)
Contribution restrictions    = None (You can continue to contribute and receive matches while making 401k loan payments)
Gotch ya's               = Miss out on returns. If you leave your company, 100% of the outstanding balance is due.
Bi-Monthly Payment         = 468.52


Brief summary of our current financial status.

Non tax sheltered savings    = 21,000 (Money we could use towards a flip)
Tax Sheltered Investments   = 203,000
Home Equity/Other         = 55,000

Total Net Worth            = 278,000


Current gross income = 120-130k/yr (Before taxes, insurance, HSA contributions, and two 401k account contributions.)

Our current savings rate is around 60-70% which allows us to max our 401k's, HSA's, and IRA's.  Our high savings rate does give us flexibility in our budget.  If things went wrong we could easily cash-flow the 401k loan repayment.  Obviously there are risks involved but the 401k loan is starting to look like a pretty good deal for accessing tax sheltered investments for short term non tax sheltered investing (House Flipping).

I would love to know your thoughts on this situation and if you would take advantage of the 401k loan.  Please point out any disadvantages that I am missing.

Also, we are in our mid 20's if that helps anyone...

Thanks in advance!
I would not..

If you can not make the finances work without a 401k loan, it does not seem worth the risk. If I were you, and wanted house flipping to be in my future, I would wait 1 more year. With your savings rate, you will have the $50,000 that you could get from the 401k loan in about 12 months. Max out all your pretax investments, and then dedicate the rest to your flip-fund. I know it was not what you wanted to hear.

Something else you might not want to hear. You are mentioning some very costly items that will just slash your profits. It sounds like you are interested in using a broker. That is 6% on the purchase, and 6% again on the sale. Your GC will make his/her money, paid by you. You say the market is crap for renting, so sale of your flip will exclude landlords, limiting the number of buyers and the re-sale price.

Do you own your own home? If you have some experience with repairs and can do some of the work yourself, you stand a much better chance of having success. You can also get those skills volunteering for habitat for humanity.

FIreDrill

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #2 on: January 04, 2017, 11:24:04 AM »
I would not..

If you can not make the finances work without a 401k loan, it does not seem worth the risk. If I were you, and wanted house flipping to be in my future, I would wait 1 more year. With your savings rate, you will have the $50,000 that you could get from the 401k loan in about 12 months. Max out all your pretax investments, and then dedicate the rest to your flip-fund. I know it was not what you wanted to hear.

This is what we originally planned on doing but I'm always interested in different ways to do things.  Especially accessing retirement funds without penalty and at a low cost.

Something else you might not want to hear. You are mentioning some very costly items that will just slash your profits. It sounds like you are interested in using a broker. That is 6% on the purchase, and 6% again on the sale. Your GC will make his/her money, paid by you. You say the market is crap for renting, so sale of your flip will exclude landlords, limiting the number of buyers and the re-sale price.

We may not use a realtor since my wife is a licensed, but not practicing, agent.  As far as getting around commission, there is usually only so much you can do.  In our state the standard commission is 5-6% (2.5 of for the seller and buyer agents), so while we could possible get around 2.5% on the purchase and then 2.5% on the sale, the other 5% would most likely need to be paid out. 

Do you own your own home? If you have some experience with repairs and can do some of the work yourself, you stand a much better chance of having success. You can also get those skills volunteering for habitat for humanity.

We may directly hire and manage the reno through sub-contractors but I am not planning on doing very much myself.  In my mind, if I wanted to make money doing contract work then it would be better just to do that on the side without the risk of flipping houses.

With all that being said, I've been including commission and contractor costs in my estimates in order to add an extra layer of precaution.  If the only way we could make money is by "saving" on commission costs and doing the reno ourselves then it really isn't a successful flip, it would be easier just to be an agent/contractor and make side money that way.  We will still be focused on being efficient and saving money where we can but if we take on those roles that means increased profits from the additional work we are taking on.


FIreDrill

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #3 on: January 06, 2017, 08:57:53 PM »
Added a poll for the heck of it...

clarkfan1979

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #4 on: January 07, 2017, 02:59:04 PM »
Over the last 9 years my wife and I have invested about 50K in our 401K's. That total is worth about 80K today.

Over the last 9 years my wife and I have invested about 75K total across two rental properties. That total is worth about 425K today. We have about 375K equity and 50K from cash flow after repairs. 

Yes, I would borrow or sell a 401K for a rental property.

However, I don't have any experience with flips. I would do it with a buy and hold if the numbers worked.

bkmnky72

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #5 on: January 07, 2017, 04:56:48 PM »
I would wait one year:

Downsize your 401k down to max of $18k each = $36k
Cap your IRA to $5,500 each or $11k
You can stop saving towards HSA's since you're fairly young unless you have some major health issues.
Total: $47k or 36%

70% which is your current savings rate less 36% = 34% of your gross income or $44k/year savings towards flip down payment.  One year of waiting won't be such a bad idea.

FIreDrill

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #6 on: January 07, 2017, 05:04:15 PM »
Over the last 9 years my wife and I have invested about 50K in our 401K's. That total is worth about 80K today.

Over the last 9 years my wife and I have invested about 75K total across two rental properties. That total is worth about 425K today. We have about 375K equity and 50K from cash flow after repairs. 

Yes, I would borrow or sell a 401K for a rental property.

However, I don't have any experience with flips. I would do it with a buy and hold if the numbers worked.


Currently I don't believe buy and hold/rent is very viable in my location.  It may be in the next couple years, and we are definitely open to the possibility of buying rental properties if the numbers work, but in the current market rentals would cash flow very little after expenses/vacancies.

Right now our goal is to flip properties in order to build up a decent amount of cash for further flips/rentals.  The flips we are targeting would be close to new construction after completion, basically ripping everything out to the studs and going from there.  I would estimate 70-100k in rehab costs with profits at 40-50k after fees.

These "deals" can also be hard to find, I've seen probably 2-3 in the last two years.  This is also just through MLS and does not account for any marketing we might do.  The typical deal we are aiming for would look something like this.

ARV                        = 315k
Purchase price        = 165k
Rehab                     = 70k
Holding Costs         = 10k
Fees/Commission   = 23k

Profit                       = 47k


If the property did not sell, we would still be able to rent it out with a decent amount of cash flow.  This would be our backup plan.


FIreDrill

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #7 on: January 07, 2017, 11:39:16 PM »
I would wait one year:

Downsize your 401k down to max of $18k each = $36k
Cap your IRA to $5,500 each or $11k
You can stop saving towards HSA's since you're fairly young unless you have some major health issues.
Total: $47k or 36%

70% which is your current savings rate less 36% = 34% of your gross income or $44k/year savings towards flip down payment.  One year of waiting won't be such a bad idea.

I think our savings rate is more around 60% of NET income.

Total income after tax/med insurance = 99,000

Pre-Savings
2 401k's+match                                 = 45,000
HSA                                                    = 6,750
2 IRA's                                                = 11,000

Total Pre Tax Contributions                 = 62,750 (63.4% Net Savings rate)


The problem we are facing is that in order to save this 50k sum, we would need to stop contributing to some of our tax advantages accounts, which means paying more taxes which I have a hard time with.  We are hoping to find ways to make extra income in 2017 so we can max out all tax advantaged accounts and add 30k to savings.  But it's going to be tough to do this when almost all of our savings goes directly to tax advantaged accounts.  Essentially we will need to increase our gross income by 50k in order to meet this goal, which happens to be the potential profit of one flip. lol


JLee

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #8 on: January 07, 2017, 11:44:16 PM »
Remember you're paying back all that 401k loan money with post-tax income. It's not as good of a deal as it appears.

FIreDrill

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #9 on: January 08, 2017, 12:07:45 AM »
Remember you're paying back all that 401k loan money with post-tax income. It's not as good of a deal as it appears.

Yeah, it would be crazy if the payback was pre-tax. Imagin taking a 401k loan out and getting 68K worth of tax deferred income a year(401k contributions and loan payback)...  talk about double dipping lol

bkmnky72

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #10 on: January 08, 2017, 06:04:24 AM »
Over the last 9 years my wife and I have invested about 50K in our 401K's. That total is worth about 80K today.

Over the last 9 years my wife and I have invested about 75K total across two rental properties. That total is worth about 425K today. We have about 375K equity and 50K from cash flow after repairs. 

Yes, I would borrow or sell a 401K for a rental property.

However, I don't have any experience with flips. I would do it with a buy and hold if the numbers worked.


Currently I don't believe buy and hold/rent is very viable in my location.  It may be in the next couple years, and we are definitely open to the possibility of buying rental properties if the numbers work, but in the current market rentals would cash flow very little after expenses/vacancies.

Right now our goal is to flip properties in order to build up a decent amount of cash for further flips/rentals.  The flips we are targeting would be close to new construction after completion, basically ripping everything out to the studs and going from there.  I would estimate 70-100k in rehab costs with profits at 40-50k after fees.

These "deals" can also be hard to find, I've seen probably 2-3 in the last two years.  This is also just through MLS and does not account for any marketing we might do.  The typical deal we are aiming for would look something like this.

ARV                        = 315k
Purchase price        = 165k
Rehab                     = 70k
Holding Costs         = 10k
Fees/Commission   = 23k

Profit                       = 47k


If the property did not sell, we would still be able to rent it out with a decent amount of cash flow.  This would be our backup plan.

This scenario would mean you'd need about:

$165k x 20% dp = $33k
Rehab, closing costs,  holding costs = $103k
Total oop=$136k so more than $50k you're thinking of.  I would also put aside $ if the $70k reno won't be enough.  So basically you'd need roughly $150k. 

What about your current Roth IRA's?  How much are in there and is it enough to fund the above?  I would go this route.

Also, if you don't sell right away, how much could you rent it for if you hold a 1 year lease?  My back of the envelope calculation says $831 in mortgage at 30yr.  Add to that the cost of paying down your 401k which could run between $469-$1,300 per your calculation above, plus maintenance/vacancy costs.  Would you be able to come out ahead? 

As an alternative, if your wife have time, I would put her to Real Estate work and put most of her earnings towards SEP-IRA which she can put as much as $53k (max of 25% of her gross income) towards retirement.

clarkfan1979

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #11 on: January 08, 2017, 10:10:46 AM »
I would wait one year:

Downsize your 401k down to max of $18k each = $36k
Cap your IRA to $5,500 each or $11k
You can stop saving towards HSA's since you're fairly young unless you have some major health issues.
Total: $47k or 36%

70% which is your current savings rate less 36% = 34% of your gross income or $44k/year savings towards flip down payment.  One year of waiting won't be such a bad idea.

I think our savings rate is more around 60% of NET income.

Total income after tax/med insurance = 99,000

Pre-Savings
2 401k's+match                                 = 45,000
HSA                                                    = 6,750
2 IRA's                                                = 11,000

Total Pre Tax Contributions                 = 62,750 (63.4% Net Savings rate)


The problem we are facing is that in order to save this 50k sum, we would need to stop contributing to some of our tax advantages accounts, which means paying more taxes which I have a hard time with.  We are hoping to find ways to make extra income in 2017 so we can max out all tax advantaged accounts and add 30k to savings.  But it's going to be tough to do this when almost all of our savings goes directly to tax advantaged accounts.  Essentially we will need to increase our gross income by 50k in order to meet this goal, which happens to be the potential profit of one flip. lol


When you buy a rental house, there are many tax advantages that you can exercise.

FIreDrill

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Re: Would you take out a 401k loan to help finance a flip?
« Reply #12 on: January 08, 2017, 01:46:43 PM »


This scenario would mean you'd need about:

$165k x 20% dp = $33k
Rehab, closing costs,  holding costs = $103k
Total oop=$136k so more than $50k you're thinking of.  I would also put aside $ if the $70k reno won't be enough.  So basically you'd need roughly $150k. 

Rehab costs would be built into the loan.  So the loan would contain the cost to purchase and rehab the home.  The down payment requirement is 15% of the total loan for purchase/rehab.

So lets say there is a purchase price of 165k with a reno of 85k. Total loan amount would equal 250k.

Down payment = 37.5k
Closing costs   = 6k
Holding costs   = 10k

Total needed    = 53.5k


What about your current Roth IRA's?  How much are in there and is it enough to fund the above?  I would go this route.

Nothing in Roths at the moment.  20% instant return by contributing to pre tax accounts has been too good to pass up.

Also, if you don't sell right away, how much could you rent it for if you hold a 1 year lease?  My back of the envelope calculation says $831 in mortgage at 30yr.  Add to that the cost of paying down your 401k which could run between $469-$1,300 per your calculation above, plus maintenance/vacancy costs.  Would you be able to come out ahead? 

Mortgage + taxes&insurance would be roughly 1500/month.  Rent would be 2000 to 2200 a month, so if we assume 20% will be spent on vacancies/maintenance we would cash flow about 100 a month.  If i vacancy/maintenance are low we could cash flow 500-700 a month.


As an alternative, if your wife have time, I would put her to Real Estate work and put most of her earnings towards SEP-IRA which she can put as much as $53k (max of 25% of her gross income) towards retirement.

My wife is looking at moving into residential real estate in the next year.  The problem is she currently brings in about 45%(60K gross) of our income.  So going from a guaranteed income source to very unpredictable income scares me a bit.