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How to loan yourself money for a downpayment
Have a 401(k), brokerage, or crypto? Listen up!
Yo, yo!
Did you know you don’t have to use only cash for your down-payment?
3 types of loans you can use (instead of cash)
1. A 401(k) loan
A 401(k) loan is when you borrow money from your own retirement account to cover the downpayment. It's like borrowing money from yourself instead of from a bank or a lender. You access to your retirement funds temporarily, with the intention of paying them back over time.
Benefits and pros:
Access to your savings: You can get money from your 401(k) without selling your investments.
Low interest: The interest rate on a 401(k) loan is the prime rate + 1%. So if mortgage rates are 7%, it would usually be about 8% to borrow from your 401(k). This isn’t as expensive as some other loan programs.
No credit check: Since it's your own money, you don't need to worry about your credit score.
Cons and things to consider:
Limits on borrowing: You can't borrow all the money in your 401(k). There are limits, usually up to 50% of your account balance or a specific dollar amount.
Repayment schedule: You need to pay back the loan within a certain time, often five years. If you don't, it could mean taxes and penalties.
Miss out on growth: The money you borrow won't be growing in your 401(k), potentially missing out on investment gains.
Job changes: If you change jobs or leave your job, you might have to pay back the loan quickly, which can be tough.
Fees: Some plans charge fees for taking a loan.
While paying for your downpayment in cash might be a cheaper option, the 401(k) loan is something to consider if you don’t have enough cash on hand.
2. A brokerage account loan
A brokerage loan uses your investment portfolio as collateral to secure a loan. (These are investments in a brokerage account, not a retirement account.)
Benefits and Pros:
Keep your investments: You don't have to sell your stocks, bonds, or other investments to get the loan, allowing you to continue potentially benefiting from their growth.
Quick access to cash: Since your investments act as collateral, the loan approval process can be quicker than traditional loans.
Low interest rates: Interest rates for brokerage account loans might be lower compared to other types of loans (still more than a traditional loan).
Tax efficiency: Selling investments might trigger taxes, but a brokerage loan might offer a way to get funds without creating a tax event.
Cons and things to consider:
Market fluctuations: If the value of your investments drops significantly, you might need to add more collateral or risk facing a margin call.
Potential losses: If you can't repay the loan and the value of your investments falls, you could end up losing both the loan amount and your investments.
Interest costs: While interest rates might be lower, you're still paying more interest than a traditional loan, which adds to the overall cost of the loan.
Tips and things to know:
Understand risks: Consider the potential impact of market fluctuations on your investments and be ready to handle margin calls if needed.
Plan for repayment: Have a clear plan for repaying the loan to avoid potential losses or financial distress.
Loan terms: Understand the interest rates, repayment terms, and any fees associated with the brokerage loan.
Diversification: Make sure your investment portfolio remains diversified despite using some of your investments as collateral.
Brokerage-backed loans could be worth looking into if you have a hefty brokerage account and can support any margin calls.
3. Crypto-backed loans
Crpto-backed loans are newer, more rare, but are becoming more popular. Some lenders accept as many as 40 different cryptocurrencies as collateral, with Bitcoin and Ethereum being the most popular. The loan amount is generally a percentage of your crypto's value, and interest rates can vary.
Benefits and pros:
Maintain crypto ownership: You can still hold onto your cryptocurrencies while accessing funds, potentially benefiting from their future value appreciation.
Quick funding: The loan approval process can sometimes be faster compared to traditional loans, as crypto transactions can be processed quickly.
Flexible terms: Loan terms are often more flexible than traditional loans.
Cons and things to consider:
Volatility risk: Cryptocurrency values can be extremely volatile, which means that the value of your collateral might change dramatically.
Margin calls: If the value of your crypto drops significantly, you might need to add more collateral or face a margin call.
Interest rates and fees: Cryptocurrency-backed loans will come with higher interest rates and fees compared to traditional loans.
Tips and things to know:
Research lenders: Choose a reputable lender that offers favorable terms and clear conditions for the cryptocurrency-backed loan.
Collateral requirements: Understand how much cryptocurrency you need to provide as collateral to get your desired loan amount.
Loan-to-value ratio: The loan amount is often a percentage of your crypto's value, so be aware of the loan-to-value ratio.
Security breaches: Crypto isn’t as safe from theft as a bank. Compensation might not be guaranteed if you lose your funds to a security breach.
These seem to be riskier, but you might be interested in this if you have a huge crypto portfolio.
Obviously, I’m not a financial advisor. This is to help you understand your options outside of just cash. Do your own research and understand all the terms of any loan before you go forward with it.
If you don’t understand it, don’t do it.
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