Can You Use a 401k Loan for an Investment Property?

Overview: Using 401k Loans for Investment Properties

Whether you can use a 401(k) loan to purchase an investment property depends on your specific 401(k) plan rules—some plans permit borrowing for any purpose, while others impose restrictions. Even if allowed, there are significant considerations to bear in mind before tapping your retirement savings for an investment property. Below is an overview of what to know.

Plan-Specific Rules

1. Check if your plan allows loans for non-primary residences. Not all 401(k) plans are created equal. Some plans might let you borrow for any reason; others only permit loans for specific uses (often limited to a primary-home purchase, medical expenses, or educational costs).
2. Loan amount limits. By law, you can typically borrow the lesser of:
   • $50,000, or
   • 50% of your vested account balance
     If your vested balance is less than $20,000, there might be additional limitations.

Benefits of Using a 401(k) Loan for an Investment Property

1. Potentially lower interest rates. The “interest” on a 401(k) loan is typically paid back to your own account, which can be more appealing than paying interest to a traditional lender.
2. No credit check. Borrowing from your 401(k) does not affect your credit score and does not require a credit check, potentially simplifying the loan process.

Downsides/Risks of Using a 401(k) Loan for Real Estate Investments

1. Opportunity cost. Money borrowed from your 401(k) is no longer invested in the market. If the market performs well while your funds are out, you miss out on potential gains.
2. Repayment deadlines.
   • Typical repayment term: Most 401(k) loans must be repaid within five years, including both principal and interest.
   • Leaving your job: If you leave or lose your job, you may be required to pay back the full amount within a limited window (often 60 days). If you cannot repay in time, the loan is treated as a distribution, leading to taxes and potentially a 10% early withdrawal penalty if you’re under age 59½.
3. Tax complications. If you default on the loan or fail to repay after leaving your job, it becomes a taxable distribution. This can significantly shrink your retirement savings.
4. Reduced retirement security. Even with on-time loan repayment, you could potentially lower your long-term retirement balance since you’re removing that money from market growth—especially if you cannot make regular contributions while repaying the loan.

Alternative Strategies to Consider

1. Home Equity Loans or HELOCs (Home Equity Line of Credit). If you already own a home, a HELOC or home equity loan may offer a more flexible option with potentially favorable interest rates.
2. Cash-Out Refinancing. If mortgage rates are low and you have enough equity, refinancing your primary residence to free up cash could be an alternative.
3. Partnering or Private Money Lenders. If you’re short on cash for a down payment, consider partnering with a private lender or seeking alternative funding.
4. IRA Rollover to a Self-Directed IRA (SDIRA). In certain cases, rolling 401(k) funds into a Self-Directed IRA (if allowed) might enable real estate investing without taking a loan. However, SDIRAs come with strict rules you’ll need to follow carefully to avoid penalties.

Final Thoughts

• Check your 401(k) plan’s policy to see if non-primary-residence loans are permissible.
• Do a cost-benefit analysis: Weigh the interest you’d pay to yourself versus the lost investment growth in your 401(k).
• Know your job security and timelines: Borrowing from a 401(k) can become a ticking clock if your employment situation changes.