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I Bought A Rental Home With My 401K

So, I bought a house yesterday.

I know that it was less than two weeks ago that I told you that I had been thinking about buying a second investment property, and now here I am telling you that I’ve gone ahead and done so.

It was a quick process, really.  I had been looking at homes and contemplating buying something for about two months.  Finally, on Tuesday, May 1 my brother texted his realtor asking him to send me a list of available homes. I saw the house and put a verbal offer in on Saturday, May 5. All of the papers were signed and the deed exchanged on the 21st, only because I delayed the closing by 4 days.

This was a single family home that had been converted into a two family home years before.  The current owner had purchased new refrigerators and ranges and had updated one bathroom.  The home seemed to need minor repairs.  What I saw was that the carpet in apartment – including the kitchen (who puts carpet in the kitchen?!) – would have to be removed, and the bright pink cabinets in the apartment’s kitchen would have to be repainted.  The interior of the entire home could use a fresh coat of paint and the shag carpet in the second apartment would have to be removed if a thorough steam cleaning didn’t work.  I would also want to reinforce the balcony for the second floor.  Beyond that the yard would need the grass to be cut and the trees trimmed back somewhat and that was it.

I mentally scanned my criteria list for new rental property.

  • At least two units.  Three would be ideal. (check)
  • Outside of flood zone (check)
  • Less than $5,000 in remodeling work/repairs needed (check)
  • No major repairs such as roof, heater, gas lines needed (check)
  • Close to hospital (the main employer for the area) or good school district. (check)
  • Off street parking (2 parking spots – check)
  • Gas or electric heat (gas check)
  • Delivered with no tenants (check)

This house also had some additional benefits.  It was located on a very quiet street, had a big fenced-in back yard, and was directly across the street from the local playground.  This home would be perfect for a single working person or an older tenant, both of which I love.

My final home buying criteria was a net annual profit as close to $10,000 as possible.  I looked at the seller’s disclosure of her current fees.  According to the seller, net income was $8,890 after fees and but before debt servicing.  Not bad.

The asking price for the house was $49,900, however, it had been on the market for 186 days.  After being on the market for some time, the owner had redone the bathroom and updated the home somewhat to make it more attractive, so she was motivated to sell.  The realtor had done his homework, because he told me that they had previously accepted an offer of $40,000, but the deal had fallen apart when the new buyer was not able to obtain financing.  This is why is pays to have a realtor.  Had he not passed that nugget of information along, I would have said that the home was $10,000 more than I wanted to spend for two units and simply walked away from the home.

We moved on to see two more homes, but this house stuck in my mind as I crunched the math.  The owner had advertised the apartments for $550 in rent each per month.  This included owner paid utilities (except electric), which I wasn’t all too happy about.  If the owner pays the utilities, there is nothing to stop a resident from cranking up the heat to 90 degrees and leaving it on all day. One way to offset the costs was to raise the rent.  Looking at comparable apartments in the area on Craig’s List, I realized that I could probably rent one unit for as much as $600 per month and the other for as much as $575 per month.   Going back to my calculator, if I used those new numbers and the costs were relatively the same as the previous owner, I could expect a net profit of about $9,790.

Having crunched the figures, I turned to my realtor at the end of looking at 5 houses and told him that I was interested in this house. He recommended a lowball offer since she had been willing to sell for $40,000 before, and because I was a cash buyer asking for no concessions.  He recommended an offer of $36,000, to which I agreed.  He stepped away to call the seller’s realtor to see if they would entertain my verbal offer.  I drove off, telling the realtor to call me when he heard something back. Less than 45 minutes later, my offer had been accepted and a tentative closing date set.   So, I am now the proud owner of a duplex!

If you’re wondering where I got the cash from, I did use money from my 401(K) to finance the deal as I mentioned before.  I know that many of you believe that this was not the right thing to do, but I do think that these homes have the ability to provide me with an income for as long as I wish to hold on to the property.  Since I am 34 now, this can go far into distant future.  Also, the total purchase price including transfer fees, the title and lien search, and taxes came to $37,747.64.  I don’t know of any bank willing to finance a home for $30,000, assuming that I put 20% down.  In fact, this home only costs rough $5,000 more than my car did!

So, do you still think that I made a bad decision?  Would you have done the same?

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62 thoughts on “I Bought A Rental Home With My 401K

    • Oh, believe me, that’s also down payment money in New York as well. For that amount I’d be lucky to get just posts where a house once stood near a trash can on the side of a dark hilly road in the bad side of the Bronx. 🙂

  • Looks like you got a pretty good deal on the rental property! Hopefully you won’t get hit with the 10% early withdrawal penalty or have to pay taxes on the money you took out of your 401(k). That could be a brutal amount for the rental property to compensate over time. Although you took some funds away from your retirement plan, having monthly rental income could be a good bet later in life as passive income as well.

  • Looks like you got a pretty good deal on the rental property! Hopefully you won’t get hit with the 10% early withdrawal penalty or have to pay taxes on the money you took out of your 401(k). That could be a brutal amount for the rental property to compensate over time. Although you took some funds away from your retirement plan, having monthly rental income could be a good bet later in life as passive income as well.

  • My concern is that you liquidated a healthy portion of your 401k, which I’m assuming was broadly diversified, and decided to throw $37k in to a single investment. You gave up diversification and compound interest, for a $10,000/year profit. In the Short term i see why the house makes sense, but I think keeping money in the 401k would prove to be a much better investment in the long run. That’s my two cents at least. Best of luck getting it rented!!! 🙂

    • I totally understand your viewpoint. My viewpoint is that I am adding further diversification to my entire portfolio by adding real estate. I had invested in REITs within my 401K but my current employer does not have REITs in their plan. I’m also looking at the long term prospect of generating income as a stock would pay dividends.

    • I am not sure why everyone thinks that a 401K is the best thing around. This guy made a very sound financial decision. If you calculate it out 10k per year will be 40K in 4 years. As long as he does not blow the 10K per year then he should be fine. I think it was a very smart decision to cash out his 401K to by a house. You will get it rented because it sounds like a nice place.

    • Yeah it was $32K. That was before grad school loans and before the business opened and close. I was financially okay then…and I still have that car.

    • I took early withdraws from a Roth Ira and a traditional Ira and it has worked out great so far.I have bought two stand alone condos. One for 74000 in early 2012 and one for 79000 in Jan 2013.I
      bought them for over 40 percent less than they were built for in 2006.I paid cash for both of them, about 65 percent coming from IRAs. At 55 I am subject to 10% penalty,but much it is reduced by college education cost for two children.I have good renters and at 900$ and 1,050$ a month rent, I have an after expense cash flow of over 16,000$. This is helping to pay for there college and will supplement my pension and social security when I retire.

  • Good for you. But, your ROI will depend on the amount of money that you have to eventually put into the home, as well as the variability of your tenant’s payments.

    I understand from your previous post that money now is more beneficial to you than money in the future. I think our entire generation feels that way, especially when investing in the stock market, be it mutual funds or ETFs, carries so much uncontrollable risk.

    As long as you are bringing in a cash flow, with the thought of it to provide for retirement income, than why the hell not cash out the 401(K)? It’s not like you are using it for a new car. You are simply transferring your underlying assets from stocks to real estate.

    Assuming you maintain tenants, your $36k pays for itself in 3 years. After that, your annual ROI will be a whopping, close to a guaranteed, 33% PER YEAR. Screw conventional wisdom and do what works for you, Sandy.

    • Finally, someone else who sees it my way! I literally crunched the numbers for MONTHS and couldn’t believe that they made such perfect sense to me. I thought that I must have forgotten how to add and subtract!

      I’m still contributing to my 401(K) at a level that’s higher than needed for the company match. I’m going to end up spending around $2,000 for everything needed in the house and I ALREADY HAVE INTERESTED TENANTS CALLING!!!! The realtor is showing the house this week with the understanding that some things will be fixed. I guarantee that I will have a tenant in the home less than a month after closing.

    • I don’t mind sharing. I’m buying in Pennsylvania even though I don’t live there. Did I forget to mention that part?

  • Are you going to shove the rent back into the 401(k)? I only ask because I really see the only downside risk as the loan being called due to being fired or leaving that job. If you put your regular contributions plus the net rent you can pay that thing off QUICKLY and think about doing it again.

  • Time will tell. I personally am way too conservative with my investments to ever consider such an approach, but each person has to evaluate their own situation and it sounds like you definitely did that and put in your own due diligence. As long as it doesn’t turn into a money pit and as long as you can keep the income flowing in, you should be good, but as I said, only time will tell…

  • What an incredible deal!! Good for you for doing your homework and working with such a great Realtor.

    Back in 2006 my husband and I looked at buying small homes in Saskatchewan for between $25 and $35 K. We talked ourselves out of it and that was a big mistake because now the economy there is booming and those homes are now selling for $100 K +

    • My parents just had the same problem, except they didn’t talk themselves out, a terrible real estate agent screwed them. Now all the houses in that town are worth double, less than a year later.

  • I agree with the decision you made. It makes more sense, at least to me, to borrow from the 401 instead of taking a straight up withdrawal. Depending on your price of rental, property taxes, repairs, insurance and how often you go without a tenant, you should be able to make that money back in 5-6 years. That is a good passive income for the duration you decide to keep the home. Congrats.

  • Hi Sandy, Good job. You used your head and made your own decision. I too have found that rental income producing properties are a solid source of income and you can build it up as high as you want to go. I’d like to share with you a couple of things. Have a realtor screen tenants for you, pay or offer a fee for the service. I know this works as my wife is my realtor and knows from experience. Your tax person, if knowledgable, will tell you to buy more properties to rent out. The deductions for repairs and the depreciation will give you a decent return each year in addition to the rent. You might want to consider paying a realtor 10% to manage the properties if you find you have more than you can handle. Another thing, consider buying a yearly repair insurance plan. ‘Homeguard’ is one I’m looking at now. For $75 for each occurance they will repair anything that breaks, depending on what level of service you pay annualy for. The $75 fee could be disclosed in the tenant’s lease that they will be responsible for the repair fee.
    I can’t think of anything else. You go, girl!

  • It’s my understanding that if you want to take advantage of the pre-tax retirement savings that a 401(k) allows, you will be penalized for deducting the money early. And if you leave the company before you have repaid the loan, you have to repay the balance immediately.

  • How have things worked out so far? Have your units been rented consistently? I think that your idea is great- the whole point of a retirement portfolio is to generate income and equity– doesn’t matter how.

    • So far, so good. I’ve just replaced the 401K with a mortgage, so that loan is paid off. The apartments are both rented and the house is paying for its own costs thus far. We’ll see how I feel a year from now, but no complaints for now!

    • Yes, typically it is 50% of the vested balance of your 401K. The big difference is that you can take up to 15 years to pay off a home loan with your 401K versus the normal 5 years of regular 401K loans.

  • You could have done it by rolling over your 401k into a IRA that can purchase real estate.
    If you are self employed you would be able to get a solo 401k that can purchase real estate as well.
    In both cases you wouldn’t have any penalties.

    • You’re right, I could have rolled my money into such an IRA, but I wanted to have those funds, plus my regular contributions available for this an possibly future purchases.

    • Yes, you could have rolled some funds into a self directed 401k but there are pretty stringent rules about not benefiting in any way from a property bought within the ira. All income comes back into the IRA and all expenses must be paid from within the ira. I’m not sure if such expenses can subsequently be deducted for tax purposes given your taxes on income from the rental property would be deferred. I looked into doing this a while back and the set up fees could be close to(on a one time basis at least) as the 10% penalty on the 40k you borrowed from your 401k. BUT, you wouldn’t have to pay the taxes you originally deferred which would be a plus. I know this is a non issue for Sandy since it was a loan that has subsequently been repaid.

      All in all, it seems to me that Sandy made a good deal. I’m starting to get interested again in doing something like this myself.

      • I did pay my loan back, but I’d love to learn how I can take advantage of 401K funds for future purchases. If you can direct me to where I can learn more, I’d love to read it! The penalty aspect burns though. I don’t want to hand over 10% to the government and then have to pay taxes as well.

        • Hey Sandy

          I have provided a couple of links below:

          http://www.foxbusiness.com/personal-finance/2011/09/23/pros-and-cons-self-directed-401k/

          I haven’t made the plunge myself because I haven’t decided if I want to do it inside my retirement yet. The ability to buy gold/silver is also another plus of self directed IRA’s. As the link above suggests, do your homework on fees.

          Here is a link to a basic webinar on the topic.

          http://www.theentrustgroup.com/learning-center/webinars/1141/national-webinar-the-self-directed-ira-basics-101

          The nice thing about the self directed 401k is that with certain exceptions (which you must know like collectibles, art, antiques etc) you can invest in pretty much anything you like. Real estate, gold, silver, stocks etc. I already have a solo 401k and when I venture into this in the next few months, I will only allocate some of my portfolio to the self directed account to keep it separate from my brokerage and mutual fund stuff. It reduces the risk of any screw up on my part resulting in the IRS telling me I broke the rules and am subject to penalties and taxes because the investments are not qualifed to be tax deferred.For example, I can’t have the IRA buy a property from my father because he is an unqualified particiapant but I could have the IRA buy an apartment from my cousin. I can’t benefit in any way from real estate purchased, rental income etc. For example, I can’t rent an apartment that the IRA owns. Think of the IRA as a separate legal entity from you that must be always seen to be separate from you with no blurring of the lines between you and that entity. I’m just airing my thoughts on the topic here at this point.

          If you purchase real eastate from within a self directed 401k, there is no penalty or tax unless you take a distribution as long as you follow the rules. The account must have a custodian like all IRAs and their services are on a fee based schedule. You have to do due diligence to ensure that you aren’t nickle and dimed to death. Hope all this helps. When I eventually take the plunge myself, I’ll post an update on my success/failure here 🙂

        • Hey Sandy

          I posted a response to your question which went to moderation but it never showed up as approved. Did you get it?

          If not, just send me an email and I’ll send the info to you directly.

          Kevin

  • Hi,

    Good for you trying to diversify into rentals and not just relying on stocks! I started buying rentals 2 years ago with old IRA monies rolled into a specail account and so far it’s working out well. I’m also thinking of taking a 50K loan from my current 401K to buy another rental property and use the rental income to pay back the loan in 5 years. It would be great to have enough rentals to retire early.

    If you want a good contact for more info on using IRA monies to buy rentals send me an email. The company I used to setup this account was very good. You can’t use 401k from your current employer for it though.

    Steve

    • Hey Steve,

      I’ve heard about this from a few people but no one has provided any concrete companies that I can work with. I’ll e-mail you to get more info. What I think that I’d do is divert some of the money going to my 401K into this IRA. Thanks!

  • Your on the right track in my mind. I am purchasing my 7th rent house next week with my self directed 401K. My margins are not as good as yours but net cash flow about 12%. I am taking out a short loan for 90 days. I will pay off the loan with taking out of the 401K in January. This means you will not pay the tax and fees for 15 months. This will pay the 10% fee from interest savings. My tax rate keeps going up because of past investments so I figure pay it now because I wont be in a lower tax break in the future. So to sum it up my purchases cash flow around 12% and home prices should continue increase in my market at around 3%. I am looking at 15% RETURN ON INVESTMENT. I sleep better because I can see and understand my investment and not at the mercy of a corporation and financial advisor.

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