You believe you’ve been making all the right moves in your life, purchasing a home and investing in your 401(k). You’ve been mastering the fundamentals and playing by the rules, doing everything you should to establish your financial ground game.
And now that you’ve got your ground game cranking, you’re looking for something more….some high-flying offense to grow your wealth. You want to begin real estate investing. But after paying your mortgage, your 401(k) contributions and your life expenses, you haven’t saved the tens of thousands of dollars you need to spread the field and throw the real estate long-ball.
I get it. I’ve been in your shoes…errrr, cleats.
I know what it’s like to have the desire to begin real estate investing, but not the means.
However, all is not lost. If you want to get off the sidelines and into the game, I can tell you two winning strategies for securing the real estate investing funds you need.
2 Rental Property Financing Strategies:
Tap Into Your Home Equity
You’ve got a house and you’ve built up equity. How? Home prices across the US have been rising at roughly 4% per year (and significantly more in certain regions), and you’ve built up home equity through appreciation. In addition, you’ve been making mortgage payments every month and these payments have been increasing your principal investment. As each month passes, your home equity grows. And what are you going to do with that equity?
But how? Let’s say, for example, your home is worth $400,000 and you owe $200,000 on your current mortgage. You would have $200,000 in equity in your home. That money is yours, but you have to “tap into it” in order to get it.
3 Ways to Tap Into Your Home Equity:
- Cash-out refinance on your primary mortgage
- Home equity loan
- Home equity line of credit (HELOC)
While each of these methods has its pros and cons, I generally recommend using a HELOC because it’s a separate loan from your primary mortgage and has built-in flexibility. With a HELOC, you don’t have to borrow the full amount of your equity. Instead, you only borrow the amount needed to purchase, remodel and/or manage your rental property. The “draw period” is usually a 10 year period during which you can withdraw money and make payments on the interest only. At the end of the draw period, you must stop borrowing and begin paying back the principal and interest for the remainder of the loan term.
Once your HELOC is approved and ready, you can take out the cash you need to use for a down payment on a rental property. Prior to selecting which rental property to purchase, you will run the income and expense numbers carefully to make sure that you can cover the cost of your financing expenses. These expenses will include both your HELOC payment and your new rental property mortgage payment (unless you are able to pay for the rental property solely with the HELOC proceeds).
If you feel slightly nauseous about using a HELOC for your rental property, you should! You are substantially increasing the risk in your financial life. You are making a huge leap of responsibility from one loan payment and one property to three loan payments (HELOC + two mortgages) and two properties. Gulp.
Well I’m here to tell you…suck it up Princess. Take a couple of Tums and get over it. Because with great risk, comes great reward. And you are reading this blog because you are ready to kick it up a notch….aren’t you?
Borrow Against Your 401(k)
Although rules can vary, you can typically borrow the lesser of $50,000 or up to 50% of the value of your 401(k). The repayment period for an investment loan is typically 5 years, during which time you repay the loan, with interest, to yourself. Yes, the loan money plus interest goes right back into your 401(k)! So while you are leveraging the value of your 401(k), you are also paying yourself back with interest as a lender.
In addition, the 401(k) loan may serve to diversify your retirement account. Most likely, you have your 401(k) funds invested solely in stock and bond funds. With the loan, you will be diversifying your holdings significantly into real estate.
Downsides to a 401(k) Loan:
- If you lose your job or quit, you may need to pay your loan back, in-full, within 60 days (or incur penalties). So don’t borrow from your 401(k) unless you’re in a relatively secure employment position where you intend to remain through the repayment period.
- The loan payments are usually deducted straight from your paycheck and can be rather high, given the 5 year repayment term.
- You’ll be missing out on market appreciation while the loan money is being repaid (but again you could be earning a higher rate of return on your rental property investment).
Finally, before taking a 401(k) loan, you should carefully run the numbers and look at your overall anticipated cash-flow to ensure you have enough income to cover the 401(k) loan and mortgage payments associated with your real estate investment purchase.
These investment strategies are NOT for the baby-stepping graduates of Peace University. They’re just NOT.
If you can’t get comfortable with the idea of using leverage to grow your wealth, to you I say:
But, if you’re an investor on solid financial footing, feeling ready to take calculated risks to grow your wealth, to you I say:
I have personally used both home equity and 401(k) loans to successfully grow my rental property portfolio. It is a choice that has worked very well for me. It’s true that, at times, I’ve experienced feelings of risk and discomfort….and maybe even a little heart-stopping, cold-sweat-inducing fear. But, these funding strategies have also generated for me great excitement, challenge and reward. And I will always encourage people to put themselves out there and reach for the glory, because, with real estate investing, the payoff just keeps getting better.
So what do you think about these investing strategies? Have you (or would you) use them? Do you have any questions?
Hit me with ’em below.