My retirement plan

[smr91481]

A little about me... I'm 35 years old, married with two kids (7 &8). Been at my job for going on 9 years. I currently make a little over $100k per year, and within the next year or two will get a raise that should land me around $130k. I like my job most of the time, and will most likely work there until I decide to stop working. I have a little over $130k in my 401k and my only other savings is $10k in an emergency fund.

I've always loved real estate and have studied real estate investing for years. I've always had some reason as to why I couldn't get started in investing, but I'm about to go ahead and jump in. I'm not sure how well this will go over and maybe it's a little risky, but it's a way in and I'm going to go forward with it.

I talked to a mortgage lender who told me the requirements to get a mortgage for an investment property is a 20% down payment and reserves to cover 6 months worth of property taxes and insurance.

Here is the plan... I'm going to take a loan from my 401k to cover the down payment and 6 months worth of PITI on the house I buy. I'm going to get a 15 year fixed rate mortgage. I can afford to use $1,500 - $2,000 per month out of my pay to first pay off the 401k loan, then pay off the mortgage. The price range of house I'm looking in to should allow me to do this in less than 5 years, and the house should rent easily for $1,200 per month.

Once the first one is done I will repeat the process and use the income from the first rental to pay off the new mortgage in about 3 years.

I will rinse and repeat the process until I have a portfolio of paid for rental property that brings enough monthly income to at least match what I make at my job.

I would imagine that using 401k loans is frowned upon, but the way I look at it is that I'm using it with retirement income in mind. My 401k has earned an average of 6.8% since I've started it, so I don't think I'm taking a big loss paying myself 4.5% for the loan.

Thoughts?

 

[Another Reader]

What are the numbers on the prospective purchase? Does it meet the 1 percent per month rule? Will the leverage be positive? What's your anticipated vacancy and collection loss? Have you costed out taxes and insurance? What are you allowing for maintenance, repairs and capital improvements? Will you manage the property yourself? What is your proposed tenant selection process? What sources will you use to vet prospective tenants? What will you do if you end up with a bad tenant? How difficult is it to evict in your jurisdiction?

When you have solid answers to all these questions, then you should consider writing that first check. However, if you have to borrow from your 401(k) for the down payment, in my opinion you are undercapitalized and you are taking on too much risk. A bad tenant could exhaust your borrowed reserves quickly, and there is no place to go for more capital. In your shoes, I would save up the down payment and the reserves before investing. If you cannot do this, you should not be in the rental business. You don't have enough money.

 

[Dd852]

Sorry. Just don't borrow from a 401k for something that simply is not a one way bet. Real estate is great until it isn't, and that's when you need to be liquid and with lots of reserves.

 

[smr91481]

What are the numbers on the prospective purchase?

Does it meet the 1 percent per month rule?
Some of the properties I've been looking at online meet the 1% rule at or near list price.
What's your anticipated vacancy and collection loss?
When I'm analyzing properties I use 8% for vacancy
Have you costed out taxes and insurance?
I am able to see property taxes online and am estimating what insurance would be based on what the lender told me.
What are you allowing for maintenance, repairs and capital improvements?
I am figuring 5% for maintenance and 5% for capital improvements.
Will you manage the property yourself?
I do plan on managing the property myself, but have figured 10% for management just in case I ever decide to use a property manager.
What is your proposed tenant selection process?
I'm still in the process of doing some reading and research online on this part.
What sources will you use to vet prospective tenants?
See previous answer
What will you do if you end up with a bad tenant?
Eviction
How difficult is it to evict in your jurisdiction?
From what I've read my state seems to be pretty landlord friendly. Give the tenant a 5 day notice to vacate before filing for eviction, a court date is set for 3-4 weeks later, the tenant is given 24 hrs to vacate after the court date, and if they don't comply the sheriff or constable will remove them.

I will have an amount equal to 6 months worth of rent in an "emergency fund" for the property. And if it came down to it, I could cashflow the payment if I absolutely had to.

When you have solid answers to all these questions, then you should consider writing that first check. However, if you have to borrow from your 401(k) for the down payment, in my opinion you are undercapitalized and you are taking on too much risk. A bad tenant could exhaust your borrowed reserves quickly, and there is no place to go for more capital. In your shoes, I would save up the down payment and the reserves before investing. If you cannot do this, you should not be in the rental business. You don't have enough money.

.

 

[pb4uski]

My father invested in residential and commercial real estate when he was alive. He ultimately sold all the residential as it was more of a PITA than it was worth. The commercial property was kept and my mom still has it and I manage it for her.

To me, equities are much easier, have good returns and a low maintenance by comparison.

 

[jazz4cash]

I took several 401k loans which were a small pct of my total so no big deal. One thing I would suggest is to evaluate the cost of a 401k loan as the opportunity cost e.g. 6.8% in your case. When I took loans I generally reduced my stable value allocation to minimizes opportunity cost. It's NOT a loan since the funds in your 401k are liquidated to provide the proceeds. The idea of paying yourself interest is a misnomer.

You may also want to consider rolling the funds into a Roth or tIRA and purchase the property with these funds. You do lose some tax benefits with tIRA but using Roth funds is a plus after you get past taxes to covert. I looked into this enough to know it is possible but didn't get deep into the details.

 

[NgineER]

What are the numbers on the prospective purchase? Does it meet the 1 percent per month rule? Will the leverage be positive? What's your anticipated vacancy and collection loss? Have you costed out taxes and insurance? What are you allowing for maintenance, repairs and capital improvements? Will you manage the property yourself? What is your proposed tenant selection process? What sources will you use to vet prospective tenants? What will you do if you end up with a bad tenant? How difficult is it to evict in your jurisdiction?

When you have solid answers to all these questions, then you should consider writing that first check. However, if you have to borrow from your 401(k) for the down payment, in my opinion you are undercapitalized and you are taking on too much risk. A bad tenant could exhaust your borrowed reserves quickly, and there is no place to go for more capital. In your shoes, I would save up the down payment and the reserves before investing. If you cannot do this, you should not be in the rental business. You don't have enough money.

+1, you should consider that 50% of your income long term goes to capex, maintenance, management, vacancy, piti etc.

I too am looking at adding properties for retirement. I plan to loan 80% for every property, 30 year fixed and only pay the minimum mo they fee until I have enough properties and at that point start paying off the loans aggressively.

 

[brucethebroker]

I have borrowed against 401-k to buy properties and here is all you need to know:

If the stock market tanks, you will look like a genius.
If the market skyrockets, you might well be kicking yourself.

I am assuming you buy the "right" property, and keep it rented.

 

[smr91481]

I have borrowed against 401-k to buy properties and here is all you need to know:

If the stock market tanks, you will look like a genius.
If the market skyrockets, you might well be kicking yourself.

I am assuming you buy the "right" property, and keep it rented.

How has it worked for you? I don't plan on having it out any longer than absolutely necessary.

 

[Golden sunsets]

OP; if you can afford $1,500-$2,000 per month to pay off the 401K loan I would suggest you save that amount until you have a sufficient DP including closing costs and avoid the 401K Ioan.


Sent from my iPad using Early Retirement Forum

 

[joeea]

A little about me... I'm 35 years old, married with two kids (7 &8). Been at my job for going on 9 years. I currently make a little over $100k per year, and within the next year or two will get a raise that should land me around $130k. I like my job most of the time, and will most likely work there until I decide to stop working. I have a little over $130k in my 401k and my only other savings is $10k in an emergency fund.

Here is the plan... I'm going to take a loan from my 401k to cover the down payment and 6 months worth of PITI on the house I buy. I'm going to get a 15 year fixed rate mortgage. I can afford to use $1,500 - $2,000 per month out of my pay to first pay off the 401k loan, then pay off the mortgage. The price range of house I'm looking in to should allow me to do this in less than 5 years, and the house should rent easily for $1,200 per month.

It's a mistake in my opinion.

First, I'd suggest you grow your emergency fund significantly. $10k won't cover a lot in the way of emergencies across both your own home and a rental property. With twice the property the chance of emergencies rises.

Second, I'd suggest that you put away $1500 - $2000 per month until you have save up enough for the down payment and 6 months of PITI, instead of raiding your 401k.

Finally, are you planning on managing this property yourself? Consider learning if you enjoy and find the time for handling one before planning to handle many. Unlike many investments, this isn't passive - it's more like a second job.

 

[Fermion]

So what happens when a tenant's boyfriend moves into the house unknown to you and sets up a meth lab, then it takes you six months just to evict them while they are not paying rent? During this time of course they are renovating your house by demolishing the bedroom and living room walls plus removing the copper plumbing so you don't have to.

 

[smr91481]

Finally, are you planning on managing this property yourself? Consider learning if you enjoy and find the time for handling one before planning to handle many. Unlike many investments, this isn't passive - it's more like a second job.

I do get the part about it not being passive. I would like it to replace my current job one day. My dream job would be to manage my real estate.

 

[nash031]

I do get the part about it not being passive. I would like it to replace my current job one day. My dream job would be to manage my real estate.

You should do some digging through these forums about folks who manage their own properties. I think about rental property from time to time, but then I read up on it, and it seems like a lot more work - and tedious work, at that - than I would want to do in retirement.

 

[Fedup]

I hire people to manage mine, so no tedious work at all. That's how I get to take 4 months off in Europe. Same with my sister. My brother is the only want who manages it himself, but his property is less than 3 miles from his residence. So why not.

 

[brucethebroker]

How has it worked for you? I don't plan on having it out any longer than absolutely necessary.

More of a buy and hold guy-but it turned out great and I never regretted it. Made it possible to retire/semi-retire when my the economy wrecked my career during the recession.

When the real estate market crashed, the rents held steady. Then the market came back.

Lot's of negative advice from people who have never owned investment RE or had one property and quit, or have a friend who had one, or heard about someone who did-broken pipes, trashed properties, evictions, etc. Many people share that view-makes it possible for rest of us.

Not always easy, but the leverage and tax benefits are great-it can still be done with some self education.

 

[exnavynuke]

Have you done any calculations to determine your expected return on investment? Have you done any estimates of how much of your time will be taken up to get those returns? Have you compared that to what your expected returns and time spent to get them would be for alternative investment options? Have you considered how you would handle a local (or nationwide) real-estate price collapse with most of your net worth tied up in local real estate? Rental properties in Detroit looked like a great idea 20 years ago, last I heard they were practically giving away houses to anyone willing to live and work there though.

 

[Another Reader]

I have been doing this for over 20 years. Bought a number of properties owned or formerly owned by people that did not understand the business and were undercapitalized. If you are well capitalized and know how to run the business, you should be fine. Overconfidence and undercapitalization will add to my portfolio when you bail out.

 

[Cronan]

To me, equities are much easier, have good returns and a low maintenance by comparison.

This, I think. 100% this. You may or may not do better in Real Estate, but you will have more headaches and weekends spent painting, cutting grass, maintenance, court dates and dealing with nasty tenants than if you just bought equities.

 

[Bamaman]

You have not mentioned what kind of housing market you're in. Expensive?
How are the rental rates on homes vs. the house price?
Is there many apartments in your area that are tough competition?
What kind of occupancy rates in your community for apartments?
How strong are your carpenter, plumbing and electrical skills?

I'm in probably the lowest priced housing market anywhere, and our rental rates are fairly high due to having 2 colleges in town. But 600 apartment units are in the process of being built--possibly screwing up the rental market. I'm fully capable of rebuilding any rental house, however I'm only up to working 5 hour days--and jobs would be completed slowly. I have the cash money to pay for rental property, and have the business acumen to deal with tenants, collect and kick'em out for non-payment, vandalism, etc.

If I was you, I'd work on living well below my means, investing in 401K's to the max. your employer matches and putting additional funds into Roth IRA's until it hurts. Then spend your time and efforts studying the stock market in order to make better than normal/average returns on investment in the stock market for the next 20+ years.