If you’re a first-time home buyer, you can borrow from your 401(k) to buy a house. But I’m not so sure it’s wise to do so because you are hurting your future retirement accounts. The key to a large 401(k) portfolio is to consistently max it out and let your investments compound.
Here’s a chart that should motivate you to stay on track with your 401(k) contributions. Eventually, you will be a millionaire if you stay the course.
Let’s say my 401(k) by age chart doesn’t convince you to keep your pre-tax retirement accounts and your real estate investment accounts separate.
The IRS allows you to borrow against your 401k, provided your employer permits it. If your plan does allow loans, your employer will set the terms.
The maximum loan amount permitted by the IRS is $50,000 or half of your 401k’s vested account balance, whichever is less. During the loan, you pay principle and interest to yourself at a couple points above the prime rate, which comes out of your paycheck on an after-tax basis.
Generally, the maximum term is five years, but if you use the loan as a down-payment on a principal residence, it can be as long as 15 years. But who plans to stay at an employer for 15 years anymore? Not many.
Borrowing from your 401(k) is a good alternative because you do not need a credit check, nothing appears on your credit report, and interest is paid to you instead of a bank or credit card company.
Just remember, borrowing money means paying it back, otherwise there will be penalties.
Another thing to note. If you have an IRA, you can take up to $10,000 out of your IRA penalty-free for a first-time home purchase. If you are married, your spouse can do the same – and “first-time home” is defined pretty loosely.
Borrowing From Your 401(k) To Buy A Home Is Not Optimal
I understand the FOMO of wanting to own your property, or at least own your own house so you can stop paying rent. Real estate FOMO is the illest. It’s the American dream. Unlike owning stocks, which provide no utility or joy, at least with a house, it provides shelter and you can create wonderful memories with loved ones.
However, withdrawing from your 401(k) to the borrow money from the bank to but your first home at this point in the cycle is madness. Prices are at all-time highs in many parts of the country. Such a move could literally wipe away your entire net worth in a few short years if the real estate market turns south and you’ve got to sell. That’s what happened with many homebuyers in 2007-2008.
Instead of borrowing from your 401(k), you’re much better off building your after-tax savings and investments that can provide for a 20% downpayment. If you don’t have at least a 20% downpayment in cash plus a buffer equal to 10% of the value of the house, you probably cannot afford to buy your first home.
Leverage is great on the way up, but terrible on the way down.
Renting is good value now in many parts of the country ,especially if you live in an expensive coastal city. Take a look at my BURL strategy if you really want to invest in real estate.
For example, if it sounds absurd to pay $4,200 a month in rent for a two bedroom, two bathroom apartment in San Francisco, it is even more absurd to spend $1,350,000 buying the place! At $1,350,000, the apartment is trading at 26X annual gross rent or just a 3.6% gross yield. After property tax and expenses, we’re talking under a 3% net rental yield (cap rate), and that’s assuming no mortgage!
Personally, I’ve sold one expensive San Francisco rental home in 2017 and reinvested $550,000 of the proceeds into real estate crowdfunding investments in the heartland of America. Valuations are so much cheaper and the net rental yields for earning passive income are so much higher. There’s no reason anybody needs to live in a congested and super expensive coast city any more when technology allows all of us to be mobile. Further, companies can’t afford to pay such high wages anymore.
Invest On The Best Platforms
With real estate crowdfunding, you don’t need to risk $100,000 or more to invest in commercial real estate. Instead, you can invest for much lower amounts such as $5,000. The best real estate crowdfunding platforms today are:
1) CrowdStreet, founded in 2014, is based in Portland and connects accredited investors with a broad range of debt and equity commercial real estate investments. CrowdStreet is great because they focus primarily on 18-hour cities (secondary cities) with lower valuations, higher net rental yields, and potentially higher growth.
2) Fundrise, founded in 2012 and available for non-accredited investors. I’ve worked with Fundrise since the beginning, and they’ve consistently impressed me with their innovation. They are pioneers of the eREIT product. Most recently, they were the first ones to launch an Opportunity Fund in the real estate crowdfunding space to take advantage of new tax laws.
Both of these platforms are the oldest and largest real estate crowdfunding platforms today. They have the best marketplaces and the strongest underwriting of deals. Investors should carefully consider their own investment objectives when assessing the gamut of real estate opportunities that are available. Remember, too, that real estate investments have many risk factors, so it is important to review the full offering materials for any investment that is being evaluated.
Try Not To Borrow From Your 401(k)
Please don’t withdraw from your 401(k) or IRA to buy a house. Let your pre-tax retirement contributions grow and compound over time. Keep your FOMO for a house at bay. There’s nothing wrong with renting until you can comfortably afford to raise capital specific for your house purchase.
Work on building up the value of your 401(k) while concurrently building up your real estate capital. If you do, you’ll be much better off when it’s time to finally retire. In retirement, you need to count on your 401(k), your after-tax investments, and your side hustle to live comfortably.
No longer can you rely on a pension or Social Security. Yes, you will ideally also have a paid off house too. But to do so, you need to buy a house you can actually afford first.
Recommendation To Build Wealth
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After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing. I’ve been using Personal Capital since 2012 and have seen my net worth skyrocket during this time thanks to better money management.
About the Author: Sam started Financial Samurai in 2009 as a way to make sense of the financial crisis. He proceeded to spend the next 13 years after attending The College of William & Mary and UC Berkeley for b-school working at Goldman Sachs and Credit Suisse. He owns properties in San Francisco, Lake Tahoe, and Honolulu and has $810,000 invested in real estate crowdfunding.