Borrowing against 401K (1 Viewer)

[cubd8]

I was thinking of borrowing against my 401K in order to pay off my 2nd mortgage, and maybe do some smaller home improvements (painting, kitchen appliances, etc). My condo is significantly under water, and while the market has improved some, it may be 10 years (if ever) if it ever gets back to what I bought it for. If I take this approach, I'd be committed to paying off my 401K (bi-weekly payments) in about 3-4 years, and maybe doing so, with an improving market, will put me in a better position to potentially sell in 5 years. There are a lot of condo's in my area, and so if I do some upgrades as mentioned, it would also allow me to enjoy some of them for a few years as well as differentiate myself from other condo's that don't look any different.

If I do this, what are the pro and con's to borrowing against my 401K? Off the top of my head, I'm taking a portion of my retirement savings out of the market for some period of time (although I'm paying myself back with interest) when the market could potentially improve. I'm not going on a long vacation with this money, so I do feel I would be making a wise decision since my goal is to eventually put myself in a position to sell my condo and move into a house.

When I do my taxes next year, will there be taxes I need to pay back on this? How does that work? Is there any other things I should be thinking about (for good or bad, but mostly things that I should know before I do this)?

thanks for the help! I haven't made a decision to do this, so I'm open to hearing thoughts on this!

 

[Sand]

How secure is your job? One thing to consider is that if you are terminated your balance becomes due immediately (30 days, I think).

 

[NewlyRetired]

One thing to check in your 401k plan is this: Some plans don't let you participate if you have an outstanding loan. That means you could lose out on the free match (assuming you have a match) if your plan has this clause. Double check to see what the rules of your plan are.

Obviously the big risk is your job security. If you lose your job, some plans state you have to pay back the loan soon after termination (again this is different for different plans so check).

Read this link for some basic pros and cons.

http://retireplan.about.com/od/401kplans/a/401k_loan.htm

 

[NutterButter]

I'm not following. You want to borrow money against your 401k to pay off your 2nd mortgage which you'll have to pay back in 3-4 years? Why not just pay off your 2nd mortgage in 3-4 years with the same payment plan you're following to pay back the 401k. Yes, you'll save money on interest, but I assume your rate is really low and you risk losing more than that in lost 401k increase.

 

[jon_mx]

I'm not following. You want to borrow money against your 401k to pay off your 2nd mortgage which you'll have to pay back in 3-4 years? Why not just pay off your 2nd mortgage in 3-4 years with the same payment plan you're following to pay back the 401k. Yes, you'll save money on interest, but I assume your rate is really low and you risk losing more than that in lost 401k increase.

That part makes no sense. What I think the other idea is to use the money to make improvements. I am not sure if sinking money into an upside down house makes much sense either.

 

[The Commish]

How secure is your job? One thing to consider is that if you are terminated your balance becomes due immediately (30 days, I think).

Depends on the company. A lot of companies will still allow you to pay on it if you keep it with them.

 

[Juxtatarot]

What is the rate of the home equity loan? I doubt interest savings (less tax savings) will be greater than the expected return on the 401k.

 

[tjnc09]

Absolutely no benefit to doing that. None. Don't do it.

 

[cubd8]

How secure is your job? One thing to consider is that if you are terminated your balance becomes due immediately (30 days, I think).

My job is extremely secure.

 

[culdeus]

I can't think of a reason to do this unless your credit is so awful that even payday loan places wouldn't touch you.

 

[cubd8]

I'm not following. You want to borrow money against your 401k to pay off your 2nd mortgage which you'll have to pay back in 3-4 years? Why not just pay off your 2nd mortgage in 3-4 years with the same payment plan you're following to pay back the 401k. Yes, you'll save money on interest, but I assume your rate is really low and you risk losing more than that in lost 401k increase.

I think the interest rate on the 401K loan would be lower than the rate on my 2nd loan. I believe I'm paying roughly 8.5% interest on my 2nd loan.

Good point though - that's the downside (taking money out against the 401K that could grow). If it helps, the loan I'd be taking out is only a small subset of my overall 401K.

 

[cubd8]

I can't think of a reason to do this unless your credit is so awful that even payday loan places wouldn't touch you.

My credit score is 700+.

 

[cubd8]

I'm not following. You want to borrow money against your 401k to pay off your 2nd mortgage which you'll have to pay back in 3-4 years? Why not just pay off your 2nd mortgage in 3-4 years with the same payment plan you're following to pay back the 401k. Yes, you'll save money on interest, but I assume your rate is really low and you risk losing more than that in lost 401k increase.

That part makes no sense. What I think the other idea is to use the money to make improvements. I am not sure if sinking money into an upside down house makes much sense either.

It's an upside down home, but I also don't want to live here forever and I'd like to give myself options in 5 years or so, assuming the housing market continues to come back. Perhaps this isn't the best idea/approach to take.

I was thinking that if I paid back my 401K (at a lower rate), that would be a better approach to paying my mortgage at a higher rate.

in 5 years, I don't know what my place will be worth, but it will be difficult to sell with a 2nd mortgage on top of my primary. If I can eliminate that, pay it back, and make some upgrades (nothing that's going to kill me financially, but would in the efffort to improve the place......

 

[Doctor Detroit]

I could be wrong but borrowing against my 401k is one of the last things I'd ever do. I think it's pretty much a serious emergency option only, which doesn't seem to be the case here.

Also your housing market could bounce back in the next few years and you'd really regret doing this then, I'd probably stand pat for now.

 

[Maelstrom]

You have to look at this at not only the money you take out, but also the potential growth that money could accrue to over the next X years if you left it alone.

Let's say its $15K - over 21 years that is (according to one calculator) about $80K. Edit: actually about $20k (forgot to factor in the payback)

Now, I do believe it's a bit different to take money out in an emergency situation, but that does not sound like the case here.

 

[wilked]

There's bad ideas, then there is this

You are talking about taking money from your appreciating assets (and making a decent sized gamble) and putting it into your depreciating asset. Not a good idea

Why are you moving in 5 years?

Paint is cheap. You shouldn't need a loan to paint your house.

New appliances are a 'nice to have'. Save up, by them one by one.

What is your equity in this condo? What are similar condos selling for?

Imagine 'old cub' looking down at 'young cub' right now, what would he say with you gambling with his retirement?

 

[parasaurolophus]

Absolutely no benefit to doing that. None. Don't do it.

I always hear this, but can you show mathematically why it would be such a bad decision for the OP?

If you don't lose your match from your company and your job is secure I would like to see a mathematical downside. He is updside down and that probably means he is stuck where he is living. If he wants to move he needs to not be upside down. It is no gurantee that the market is going to continue to go up. In fact if you thought it was going to go down I would think that would be a great time to do it.

 

[wilked]

If he wants to move he needs to not be upside down.

I can promise you that there are other options

 

[Smack Tripper]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

 

[cubd8]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

Sure I'm in Illinois, SW burbs (Tinley/Orland Park).

I don't mind sharing numbers if it helps.

 

[Smack Tripper]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

Sure I'm in Illinois, SW burbs (Tinley/Orland Park).

I don't mind sharing numbers if it helps.

How far underwater are you? What did you buy at?

I'm not familiar with the area, is a Chicago bedroom community?

 

[parasaurolophus]

If he wants to move he needs to not be upside down.

I can promise you that there are other options

Which options are available without negative consequences? I am seriously asking, not arguing.

 

[Henry Ford]

I'm not following. You want to borrow money against your 401k to pay off your 2nd mortgage which you'll have to pay back in 3-4 years? Why not just pay off your 2nd mortgage in 3-4 years with the same payment plan you're following to pay back the 401k. Yes, you'll save money on interest, but I assume your rate is really low and you risk losing more than that in lost 401k increase.

That part makes no sense. What I think the other idea is to use the money to make improvements. I am not sure if sinking money into an upside down house makes much sense either.

Yeah - "my house is underwater so I'm putting money into it" is weird.

 

[Juxtatarot]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

Sure I'm in Illinois, SW burbs (Tinley/Orland Park).

I don't mind sharing numbers if it helps.

For those that don't know, that's not a bad area. He should see average annual increases assuming the Chicago area economy does OK.

 

[Juxtatarot]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

Sure I'm in Illinois, SW burbs (Tinley/Orland Park).

I don't mind sharing numbers if it helps.

For those that don't know, that's not a bad area. He should see average annual increases assuming the Chicago area economy does OK.

And I doubt you could be very upside-down. Probably 10-20% at most.

 

[Maelstrom]

Absolutely no benefit to doing that. None. Don't do it.

I always hear this, but can you show mathematically why it would be such a bad decision for the OP?

If you don't lose your match from your company and your job is secure I would like to see a mathematical downside. He is updside down and that probably means he is stuck where he is living. If he wants to move he needs to not be upside down. It is no gurantee that the market is going to continue to go up. In fact if you thought it was going to go down I would think that would be a great time to do it.

I gave some of the math up-thread - $15K over 21 years = apprx. $80k without any additions, just "standard" market growth. Obviously if you think that the market isn't going to continue to grow, that's a different story. Edit: actually about $20k (forgot to factor in the payback)

 

[wilked]

If he wants to move he needs to not be upside down.

I can promise you that there are other options

Which options are available without negative consequences? I am seriously asking, not arguing.

Options without negative consequences? Lottery tickets

Options with overall best outcome - walking away from the house, short sale, living there longer than 5 years

He says he wants to move in 5 years. I see 2 main options:

1) He is severely underwater (outstanding debt 20% more than house is worth) - stop paying today, live there til they kick you out, rent for 7 years, then buy a new place

2) He is only slightly underwater (outstanding debt 10% or less more than house is worth) - go to home depot to buy the paint out of paycheck dollars, buy appliances as you can afford them with regular savings, wait until house is back above water (even if it means longer than 5 years), then sell

Everyone has a secure job, until the day they don't. 401k loans should only be made if you can realistically pay it back within 30 days if push comes to shove

 

[parasaurolophus]

Absolutely no benefit to doing that. None. Don't do it.

I always hear this, but can you show mathematically why it would be such a bad decision for the OP?

If you don't lose your match from your company and your job is secure I would like to see a mathematical downside. He is updside down and that probably means he is stuck where he is living. If he wants to move he needs to not be upside down. It is no gurantee that the market is going to continue to go up. In fact if you thought it was going to go down I would think that would be a great time to do it.

I gave some of the math up-thread - $15K over 21 years = apprx. $80k without any additions, just "standard" market growth. Obviously if you think that the market isn't going to continue to grow, that's a different story.

Do you have a link to the calculator? I thought 401k loans had to be repaid in 5 years?

If the OP has a loan that he is paying 8% on and it is a bad move to take 401k money out to repay this loan then doesnt that mean that everybody that has access to money at 8% interest or better should borrow whatever they can get their hands on in order to make sure they put in at least 17k a year into their 401k?

 

[skol asylum]

In 2010 I borrowed from my 401k to buy our first home. At the time and looking back I believe it was absolutely the right thing to do. I got into the market at the bottom and at historically low rates. I made sure to pay myself back over 5 years instead of 10 as you are allowed to when taking out to buy a home. Given similar circumstances I would do it again.

 

[tjnc09]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

Sure I'm in Illinois, SW burbs (Tinley/Orland Park).

I don't mind sharing numbers if it helps.

Is Illinois a non recourse state? That is, if you foreclosed on your home, can the mortgagee legally sue you?

 

[Juxtatarot]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

Sure I'm in Illinois, SW burbs (Tinley/Orland Park).

I don't mind sharing numbers if it helps.

Is Illinois a non recourse state? That is, if you foreclosed on your home, can the mortgagee legally sue you?

No, they can sue.

 

[culdeus]

In 2010 I borrowed from my 401k to buy our first home. At the time and looking back I believe it was absolutely the right thing to do. I got into the market at the bottom and at historically low rates. I made sure to pay myself back over 5 years instead of 10 as you are allowed to when taking out to buy a home. Given similar circumstances I would do it again.

You realize the stock market basically went vertical from 2010 up to this point? you will never recover that loss. But i'm sure your current home is wonderful!

 

[Maelstrom]

Absolutely no benefit to doing that. None. Don't do it.

I always hear this, but can you show mathematically why it would be such a bad decision for the OP?

If you don't lose your match from your company and your job is secure I would like to see a mathematical downside. He is updside down and that probably means he is stuck where he is living. If he wants to move he needs to not be upside down. It is no gurantee that the market is going to continue to go up. In fact if you thought it was going to go down I would think that would be a great time to do it.

I gave some of the math up-thread - $15K over 21 years = apprx. $80k without any additions, just "standard" market growth. Obviously if you think that the market isn't going to continue to grow, that's a different story.

Do you have a link to the calculator? I thought 401k loans had to be repaid in 5 years?

If the OP has a loan that he is paying 8% on and it is a bad move to take 401k money out to repay this loan then doesnt that mean that everybody that has access to money at 8% interest or better should borrow whatever they can get their hands on in order to make sure they put in at least 17k a year into their 401k?

Oops, yah, I forgot to factor in the payback over 5 years.

New math, the difference between $15K growth at 8% over 5 years and paying back the loan $3k per year for 5 years is $3,862.25.

Over 21 years, at 8%, the difference would cost about $20,662.46.

So that is still a significant amount, but not quite the same as the original $80k which didn't factor in payback.

There are a lot of 401K calculators, here is one of the ones I used:

http://www.bloomberg.com/personal-finance/calculators/401k/

 

[Henry Ford]

In 2010 I borrowed from my 401k to buy our first home. At the time and looking back I believe it was absolutely the right thing to do. I got into the market at the bottom and at historically low rates. I made sure to pay myself back over 5 years instead of 10 as you are allowed to when taking out to buy a home. Given similar circumstances I would do it again.

You realize the stock market basically went vertical from 2010 up to this point? you will never recover that loss. But i'm sure your current home is wonderful!

Eh, depends on how much he took out. Home values in some areas have gone just as vertical.

 

[wilked]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

Sure I'm in Illinois, SW burbs (Tinley/Orland Park).

I don't mind sharing numbers if it helps.

Is Illinois a non recourse state? That is, if you foreclosed on your home, can the mortgagee legally sue you?

No, they can sue.

which happens about as often as winning that lottery ticket mentioned earlier

Yes, they are not a non-recourse state. In practice, they are a non-recourse state

 

[Juxtatarot]

Write off the loss on the housing. The market corrected and the number it WAS at was artificially high. Its wrong to treat this as a baseline things will correct to.

Can I ask what state and general area you live in?

Sure I'm in Illinois, SW burbs (Tinley/Orland Park).

I don't mind sharing numbers if it helps.

Is Illinois a non recourse state? That is, if you foreclosed on your home, can the mortgagee legally sue you?

No, they can sue.

which happens about as often as winning that lottery ticket mentioned earlierYes, they are not a non-recourse state. In practice, they are a non-recourse state

The home equity loan is the one to be concerned with. I'm an Illinois lender and if that loan were ours, I would sue from the sound of things. I agree, though, suing is rare.

 

[wilked]

Jux, good point on the home equity loan, I missed that in the first read.

You say you might sue, but what if he has no assets? Is it realistic to go after his wages? From everything I have read the odds of getting a judgment on that are very low.

Still, it is a good point, you might need to pay off that home equity before walking away. The good news is that foreclosure takes a while and you should be able to save well in that duration

 

[Juxtatarot]

Jux, good point on the home equity loan, I missed that in the first read.

You say you might sue, but what if he has no assets? Is it realistic to go after his wages? From everything I have read the odds of getting a judgment on that are very low.

Still, it is a good point, you might need to pay off that home equity before walking away. The good news is that foreclosure takes a while and you should be able to save well in that duration

He has good credit and a stable job. He also has the ability to pay. I don't have all the details so I can't say for certain, but as the second mortgagee, I suspect I would have no interest in the foreclosure. I could get a garnishment the same as if it were an unsecured loan. He'd have to skip or file BK to stop it.

 

[skol asylum]

In 2010 I borrowed from my 401k to buy our first home. At the time and looking back I believe it was absolutely the right thing to do. I got into the market at the bottom and at historically low rates. I made sure to pay myself back over 5 years instead of 10 as you are allowed to when taking out to buy a home. Given similar circumstances I would do it again.

You realize the stock market basically went vertical from 2010 up to this point? you will never recover that loss. But i'm sure your current home is wonderful!

Yes im aware of lost appreciatoon but it wasnt all heading upwards since 2010. The $100k appreciation ive seen since I bought helps a bit.

 

[wilked]

In 2010 I borrowed from my 401k to buy our first home. At the time and looking back I believe it was absolutely the right thing to do. I got into the market at the bottom and at historically low rates. I made sure to pay myself back over 5 years instead of 10 as you are allowed to when taking out to buy a home. Given similar circumstances I would do it again.

You realize the stock market basically went vertical from 2010 up to this point? you will never recover that loss. But i'm sure your current home is wonderful!

Yes im aware of lost appreciatoon but it wasnt all heading upwards since 2010. The $100k appreciation ive seen since I bought helps a bit.

congratulations on getting lucky

 

[Doctor Detroit]

Agreeing with Wilked a lot in here.

 

[skol asylum]

Sure but who really thought the market would also appreciate like it did after completely falling apart. My point was that there is no rigid one size fits all answer for this question.

 

[Wildcat]

I've always heard you shouldn't borrow either. But for planned purchase, is it better to place extra money in your 401k and borrow against it rather than putting that money in savings? Let's say you saved $300 per month for 5 years. Wouldn't it be better to place that $300 in your 401k and take a loan instead of putting that $300 in a savings account? With the earnings from the 401k for 5 years you would come out ahead, right? I honestly don't know so I'm curious.

 

[stbugs]

I have no idea on all the mortgage stuff, but I don't think it is always bad to borrow against a 401k. I just look at it simply. If the loan is 8%+ and the 401k loan is 4%, then ignoring tax implications (which aren't really much unless this guy is making a lot) you are talking almost 4% gain over the next 5 years. With the stock market going crazy the last few years, assuming missing out on a nice gain is not a great assumption. In fact, if the stock market corrects, he could end up with an extra gain by taking a lump sum out now and investing it at a lower level.

I just don't see it that cut and dry based on the fact that he would be saving money with no assumptions or changes over the next 5 years. Yes, there are some risks and there are some potential missed and gained opportunities, but there is also one definite that he would save 4% on the money borrowed.

 

[wilked]

I've always heard you shouldn't borrow either. But for planned purchase, is it better to place extra money in your 401k and borrow against it rather than putting that money in savings? Let's say you saved $300 per month for 5 years. Wouldn't it be better to place that $300 in your 401k and take a loan instead of putting that $300 in a savings account? With the earnings from the 401k for 5 years you would come out ahead, right? I honestly don't know so I'm curious.

you only get to borrow half of the money in the 401k to protect you from you. So that $300/month into 401k becomes $150/month. Also, you have to pay that back, so now you get to pay the mortgage note plus the $150/month. That money you took out was pretax and you pay it back with post tax. Then later (30 years later) when taking money from your 401k it gets taxed again. And if you leave the job it all comes due at once.

Also, you say 'with all the earnings from the 401k for 5 years'

http://cdn-2.stocks-for-beginners.com/image-files/dow-jones-index-1900-2010.jpg

There's a whole lotta 5 year periods in there where you finish up lower than you started...

 

[Wildcat]

I've always heard you shouldn't borrow either. But for planned purchase, is it better to place extra money in your 401k and borrow against it rather than putting that money in savings? Let's say you saved $300 per month for 5 years. Wouldn't it be better to place that $300 in your 401k and take a loan instead of putting that $300 in a savings account? With the earnings from the 401k for 5 years you would come out ahead, right? I honestly don't know so I'm curious.

you only get to borrow half of the money in the 401k to protect you from you. So that $300/month into 401k becomes $150/month. Also, you have to pay that back, so now you get to pay the mortgage note plus the $150/month. That money you took out was pretax and you pay it back with post tax. Then later (30 years later) when taking money from your 401k it gets taxed again. And if you leave the job it all comes due at once. Also, you say 'with all the earnings from the 401k for 5 years'

http://cdn-2.stocks-for-beginners.com/image-files/dow-jones-index-1900-2010.jpg

There's a whole lotta 5 year periods in there where you finish up lower than you started...

I'm not talking about only $300 a month. I'm talking about $300 a month over and above what you are already giving. So you could take 100% of that amount out. I get your other points, but if those 5 years have great earnings, it could be a decent option, no?

 

[uconnalum]

Here is another scenario. A couple of years ago I had a chance to buy a rental property but was a couple of thousand short for the 20% down. I took out a loan against my 401k repaid it back in 10 months and still made same 401k contribution and received company match during repayment period. Would do it again if I have to since I am not impacting my contribution. If you take a loan but then you lower your rate of contribution to your 401k that is a big NO NO.

 

[tjnc09]

Absolutely no benefit to doing that. None. Don't do it.

I always hear this, but can you show mathematically why it would be such a bad decision for the OP?

If you don't lose your match from your company and your job is secure I would like to see a mathematical downside. He is updside down and that probably means he is stuck where he is living. If he wants to move he needs to not be upside down. It is no gurantee that the market is going to continue to go up. In fact if you thought it was going to go down I would think that would be a great time to do it.

What is the point of dumping money into a home that is underwater?

I would rather file bankruptcy if I don't want my underwater home anymore than take out a loan against my retirement account (which is protected in bankruptcy filings)

 

[tjnc09]

I will add I have been called by my realtor who sold me the villa off of Hilton Head if I was interested in selling the villa for double what I paid it in 2012. I tell him thanks but no thanks since it is a rental machine. No funds in my 401k could have given me a 100% return since 2012 like this villa has.

What does that have to do with the original poster's question?

 

[parasaurolophus]

Still would like to see some more math here...

Lets say I have a loan that I owe 15k on and am paying 8% interest on. Lets say I can borrow against my 401k and I can pay it off.Then I can pay my 401k back in 5 years.

So I would save myself 3249 dollars in interest payments. I would be losing out on the gains on the 15k taken out of the 401k. If the 15k was left untouched it would be worth $22354 in 5 years. At the 5 year payback rate it would be worth $18492. Which is a difference of 3862. So basically you lose out on $613. Right?

I guess you would also have to calculate that the 3862 gain is pre tax and the 3249 savings is post tax. So perhaps you could easily cancel the 613 lost by increasing your monthly contribution to your 401k which is pretax. So if you were taxed a net total of 20% of the 3249 that would be $812. If you put that 812 into your 401k now you come out ahead. Since the interest you are paying on the 401k loan is going back to yourself, I dont think you can truly count it as an expense. Sure it affects cash flow, but it is your money. To be honest now that I think about it the interest you are paying yourself could be enough extra money to get you back above where you would have been 5 years from now had you not touched the 401k.

Is my math incorrect here?