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Should You Tap Your 401(k) to Buy Real Estate?

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English: New housing estate in Downham Market ...

There was a recent article on the CNN/Money website entitled Amateur investors tap 401(k)s to buy homes that discussed an increasing trend of 401(k) investors who tap their accounts to buy houses.  The thought process is to take advantage of the hot housing market in some areas on the country with money that would otherwise be locked up in a 401(k) until retirement.  Home prices are appreciating in some markets, so what’s wrong with this strategy?

Plenty is wrong with it, let’s take a look.

You distrust Wall Street but you trust the housing market?  Really? 

The article cites the distrust that some of these investors have of Wall Street and a desire to own hard assets.  I get the distrust of Wall Street in the wake of the 2008-2009 market drop.  These same folks must have short memories regarding the role that the drop in housing values played in the recession and the lingering effects of on many families.  Yes prices are low, but they are rising.  Are you knowledgeable enough to know if the property that you are buying is really a good deal?  Distrust Wall Street all you want, but the fact of the matter is that investors who hold a reasonably diversified portfolio saw their 401(k) and other investments recover within a couple of years of the 2009 market bottom.

Are you getting in too late? 

According to the article, Wall Street Investors are also entering this market and in some cases have bid up the price of homes in many of these hot markets.  Much like the John Hancock TV commercial touting the idea of getting back into the stock market now that it is at new highs, is this an ideal time to be taking your retirement funds and investing them into a “hot” housing market?

Are you smarter than the professional investors? 

As mentioned above this opportunity has come to the attention of Wall Street investors.  Think what you want about Wall Street, these firms have the resources in terms of capital and research that you don’t.  I’m not saying that individual investors can’t outdo the professionals, but ask yourself are you one of these real estate investors who can?  Do you want to risk your retirement savings to find out?

Understand the potential costs and risks 

In order to get at your money in a 401(k) plan you will likely need to take a loan from the plan.  There are no tax consequences of doing this and as long as you repay the loan there won’t be any.  Understand, however, that if you leave your job before fully repaying the loan, any remaining loan balance could end up becoming a distribution which would trigger income taxes and a 10% penalty if you are under 59 ½.

Further there is a potential opportunity cost.  Are you convinced that your real estate investment will outperform what you might have gained in your 401(k) plan?  Additionally, if your investment goes south you might end up with a property that is worth less than you paid for it, you are paying back your loan on the 401(k), and the house might be underwater if there is a mortgage involved.

Look before you leap 

Let’s be clear, I’m not against investing in real estate, in fact many have made their fortunes from doing just that.  What I am against is a novice who has read about the opportunities in the housing market taking funds from their 401(k) and investing in something they barely understand.

Will this always end badly?  No.  This might be a successful route to take for someone who understands real estate investing and who understands the risks.  If this doesn’t describe you ask yourself is this a good use of my retirement funds?

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Comments

  1. This is a great overview. It’s amazing to me how quickly people forget about the downfall of the housing market. I know prices are down, but who’s to say they won’t go down again? Plus, real estate isn’t as much of a passive investment as the stock market is. It requires quite a bit of time and work in order to make money off of it. I’m with you, I really like real estate, but I wouldn’t ever think about cashing out (or taking a loan out) of my 401k in order to buy a rental property.

    • Roger Wohlner says:

      Jake thanks for your comment. People in general have short memories and I think this especially applies to investors sometimes. As I mentioned nothing wrong with investing in real estate and this housing market has created some good opportunities. However this is not a good way to fund that investment in my opinion.

  2. Wow, I actually just wrote a post on this exact article. ;) Mine will be going up in a couple of weeks though. I think you’re spot on Roger and think it’s crazy that people are doing this. I think it’s taking on too much risk…especially if it does result in a situation where you’re unable to repay the loan.

    • Roger Wohlner says:

      John great minds clearly think alike LOL. For most folks the potential risks and their lack of expertise in real estate investing make this a really bad idea.

  3. Sandy says:

    I did it. Twice. And I don’t regret it even a little. I wrote something about a year ago on why I did what I did. Those loans were quickly paid back (within a few months) and I own one home free and clear and was able to back into a mortgage on the other.

    • Roger Wohlner says:

      Sandy thanks for your comment. Congratulations you are the exception for whom this is a viable strategy. I wrote the post in reaction to the article talking about amateurs who just want to jump on the bandwagon and really don’t know what they are doing and probably don’t understand the risks. Also I suspect the real estate market in your area was a better value a year ago.

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