Borrowing against 401K (1 Viewer)

[stbugs]

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?

That seems decent enough, the only caveats are that the 3249 is fixed, i.e. fixed rates for both loans. The 3862 is assuming an almost 50% stock market gain in 5 years. Seeing as how the market went up 115% the last 5, that seems like a tough sled and a pretty big assumption. As I mentioned above, if there is some sort of pull back sooner rather than later, it is possible that you could get a gain via dollar cost averaging by paying back the loan over 5 years instead of just leaving it sitting there. For instance, take 2002 to 2006, money invested via the loan in the first 3 years of the 5 year loan were almost all at or well below the starting value, so you made more on that money than leaving it in the 401k. Year 4 was on average only a few percent more and Year 5 was a good amount more, but you also made more on the Year 1-3 money, so likely a wash and your gain by taking the loan would probably be around $3500+. If 2009 to 2014 had been a bad 5 years, then I would most likely say that you are losing money by taking the loan, but it was a great 5 years and there is a small change that it will be better even if you don't pay off a higher interest loan.

 

[ghostguy123]

I can see some situations where it makes sense to borrow from the 401k.

Not sure this is one of them. If you are planning to move in five years, why put a bunch of money into the house anyway??

Forget all the market investment talk for a minute. Generally iif you put X-amount of dollars into home improvements you only get like 80% of that back when you sell, and that is if you sell pretty much right away.

You do some renovation and improvements now, they may not even look like you did them 4-5 years from now.

Take whatever money you would use for any major renovation and put it towards your mortgage. If you wanna paint, or get 1-2 new appliances fine (dont buy top of the line stuff, you wont get anywhere near the return that they cost when you sell) then fine. Dont redo a bathroom, or do countertops, or any of that stuff unless you are a professional and are doing it yourself for the cost of the supplies.

There are ways to make your house look good to potential buyers without dumping money into it. Look those up when you are maybe 6 months away from selling and start doing those things to your house/yard.

.................but if you are deadset on moving, and your only hope is to dump a bunch of money into the house to be able to sell..................F it, stop paying and wait for them to foreclose on you in like 2 years, and by then you will have saved up a lot of money. If at that point for some reason you still want to keep the house, try and renegotiate with the bank. If that doesnt work, file bankruptcy.

 

[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?

That seems decent enough, the only caveats are that the 3249 is fixed, i.e. fixed rates for both loans. The 3862 is assuming an almost 50% stock market gain in 5 years. Seeing as how the market went up 115% the last 5, that seems like a tough sled and a pretty big assumption. As I mentioned above, if there is some sort of pull back sooner rather than later, it is possible that you could get a gain via dollar cost averaging by paying back the loan over 5 years instead of just leaving it sitting there. For instance, take 2002 to 2006, money invested via the loan in the first 3 years of the 5 year loan were almost all at or well below the starting value, so you made more on that money than leaving it in the 401k. Year 4 was on average only a few percent more and Year 5 was a good amount more, but you also made more on the Year 1-3 money, so likely a wash and your gain by taking the loan would probably be around $3500+. If 2009 to 2014 had been a bad 5 years, then I would most likely say that you are losing money by taking the loan, but it was a great 5 years and there is a small change that it will be better even if you don't pay off a higher interest loan.

Obviously the x factor is what will the market do. Somebody faced with this decision in 2005 and borrowed from their 401k is pretty happy. Somebody that did it in 2009 isn't.

 

[Dragons]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains.

That said, I wouldn't borrow if I were in the OPs shoes.

 

[stbugs]

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?

That seems decent enough, the only caveats are that the 3249 is fixed, i.e. fixed rates for both loans. The 3862 is assuming an almost 50% stock market gain in 5 years. Seeing as how the market went up 115% the last 5, that seems like a tough sled and a pretty big assumption. As I mentioned above, if there is some sort of pull back sooner rather than later, it is possible that you could get a gain via dollar cost averaging by paying back the loan over 5 years instead of just leaving it sitting there. For instance, take 2002 to 2006, money invested via the loan in the first 3 years of the 5 year loan were almost all at or well below the starting value, so you made more on that money than leaving it in the 401k. Year 4 was on average only a few percent more and Year 5 was a good amount more, but you also made more on the Year 1-3 money, so likely a wash and your gain by taking the loan would probably be around $3500+. If 2009 to 2014 had been a bad 5 years, then I would most likely say that you are losing money by taking the loan, but it was a great 5 years and there is a small change that it will be better even if you don't pay off a higher interest loan.

Obviously the x factor is what will the market do. Somebody faced with this decision in 2005 and borrowed from their 401k is pretty happy. Somebody that did it in 2009 isn't.

Agreed, which is why the OP needs to weight all the angles and decide for himself. There is always gray, hard to talk in absolutes as some do above when the biggest "good" versus "bad" choice comes from a variable no one can predict.

 

[culdeus]

Wilked is the man. You all are lucky that he puts up with this place and offers insight that 99% of people if they followed would be in a substantially better position later in their life.

 

[NewlyRetired]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains..

I don't think I understand your bolded point.

He is not making ~5% on the investment, he is making 0%. The money he pays back to himself can just be thought of as moving money from one pocket to another. One pocket will have more at the end and one will have less.

 

[stbugs]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains..

I don't think I understand your bolded point.

He is not making ~5% on the investment, he is making 0%. The money he pays back to himself can just be thought of as moving money from one pocket to another. One pocket will have more at the end and one will have less.

True, but most people who are forced to save tend to save more. People are people and I know that many see money in their bank and think about ways to spend it.

 

[culdeus]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains..

I don't think I understand your bolded point.

He is not making ~5% on the investment, he is making 0%. The money he pays back to himself can just be thought of as moving money from one pocket to another. One pocket will have more at the end and one will have less.

True, but most people who are forced to save tend to save more. People are people and I know that many see money in their bank and think about ways to spend it.

You mean like spending 401k money?

 

[stbugs]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains..

I don't think I understand your bolded point.He is not making ~5% on the investment, he is making 0%. The money he pays back to himself can just be thought of as moving money from one pocket to another. One pocket will have more at the end and one will have less.

True, but most people who are forced to save tend to save more. People are people and I know that many see money in their bank and think about ways to spend it.

You mean like spending 401k money?

Nope. Pretty sure the OP was talking about taking a loan to pay off another high interest one. Also, spending is the wrong word choice. If he closed the 401k and bought a car, that would be spending.

 

[tjnc09]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains..

I don't think I understand your bolded point.He is not making ~5% on the investment, he is making 0%. The money he pays back to himself can just be thought of as moving money from one pocket to another. One pocket will have more at the end and one will have less.

True, but most people who are forced to save tend to save more. People are people and I know that many see money in their bank and think about ways to spend it.

You mean like spending 401k money?

Nope. Pretty sure the OP was talking about taking a loan to pay off another high interest one. Also, spending is the wrong word choice. If he closed the 401k and bought a car, that would be spending.

A car would be a better use of his money than putting it towards a home that is underwater.

 

[heckmanm]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

At least, this is the case with my current plan.

 

[fightingillini]

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.

I did the same thing, but in 1998. Had 25K ready for a downpayment, but I borrowed $10K from my 401(k) so I could put enough down to avoid paying PMI. Best decision that I ever made. I saved a nice chunk of money by not paying PMI, and I sold that house 4 years later for $75K more than I bought it.

I ended up leaving my company 3 years after taking the loan, so I ended up paying the taxes and the 10% penalty on the remaining balance. By then the balance was only about $6K (I was paying it back with a 5 year loan). So the penalty was only $600. Well worth the equity that I accumulated and the savings from not paying PMI.

Would I borrow again from my 401(k)? Probably not.

 

[NewlyRetired]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

The $50k principle put in using after tax dollars would not be taxed again upon withdrawal. Any growth on the 50k would.

 

[Moe.]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

At least, this is the case with my current plan.

Yeah, but you don't pay taxes on the loan, so other than the interest this is a wash.

 

[Moe.]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

The $50k principle put in using after tax dollars would not be taxed again upon withdrawal. Any growth on the 50k would.

Typically it goes back into the same source it came out of, so the money you replace would still be tax-deferred.

If you borrow 10K, you are receiving 10K in pre-tax money that you do not have to claim as income. The way this gets reconciled is you return after-tax dollars from your paycheck to the plan. So you are cancelling out a portion of the loan each time you make a payment. You are only double-taxed (if you want to call it that) on the interest payments.

 

[heckmanm]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

The $50k principle put in using after tax dollars would not be taxed again upon withdrawal. Any growth on the 50k would.

Typically it goes back into the same source it came out of, so the money you replace would still be tax-deferred.

If you borrow 10K, you are receiving 10K in pre-tax money that you do not have to claim as income. The way this gets reconciled is you return after-tax dollars from your paycheck to the plan. So you are cancelling out a portion of the loan each time you make a payment. You are only double-taxed (if you want to call it that) on the interest payments.

OK, I misread it then. I just skimmed my company's website and saw the note about double-taxation.

 

[Moe.]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

The $50k principle put in using after tax dollars would not be taxed again upon withdrawal. Any growth on the 50k would.

Typically it goes back into the same source it came out of, so the money you replace would still be tax-deferred.

If you borrow 10K, you are receiving 10K in pre-tax money that you do not have to claim as income. The way this gets reconciled is you return after-tax dollars from your paycheck to the plan. So you are cancelling out a portion of the loan each time you make a payment. You are only double-taxed (if you want to call it that) on the interest payments.

OK, I misread it then. I just skimmed my company's website and saw the note about double-taxation.

I would trust the information on their website over anything people say here as far as specifics are concerned. Different plans can have different rules. The whole double-taxation thing is a pretty common misconception though. Loans are still a pretty bad idea in most situations.

 

[LarryAllen'sJockstrap]

Here's what I understand after researching and taking out a 401K loan myself.

Positives:

- You have the money you need to do what you need to do immediately.

- No credit score impact if you lose your job and default on it. However, you will be taxed on the remaining principal of the loan the year you default. If you took a 10K loan, payed back 5K, lost your job and then defaulted on the remaining 5K, you're in the clear credit score wise, but will owe takes on the you 5K defaulted on.

- You are paying yourself back the interest, so depending on the way you plan to use the money, it could be a long term cost savings. If you're paying off a high interest loan or settling credit card debt, it might save you a decent amount of money. You'd have to run the numbers.

Negatives:

- Many companies don't allow 401K loans. It is a company option and not state or federally manadated to allow it (unless it's a hardship I believe, which is medical, primary residence loan payment...)

- Your company will start deducting from your paycheck within a couple of weeks after taking the loan, and will continue to until it is paid or you don't work there. The amount is based on the loan amount and payback time. This is probably the biggest negative. The money you payback the loan with is after tax, while most 401K contributions are pre-tax. Once you retire and start using your 401K, you get taxed on it; thus you'll end up getting double taxed on that loan over the life of the 401K.

- Some companies prevent you from contributing to your 401K while you have an outstanding loan.

- There is a 10% penalty if you default. If you owe 5K, I beleive you get taxed for 5.5K.

When I took my loan, I was in a situation where I needed the money, have a job I've been at for 12 years straight out of college and feel safe for now. Our company allows loans, and also allows us to continue contributing while I'm paying it off. I hope I don't have to default, and maybe there were other, better banking or other types of loans I could have gotten, but I did what I did and don't think I'll regret it too much if I can keep my job and pay it off. The sad thing is in the first year, my contributions and gains grew my 401K to more than it was before I took the loan.

 

[LarryAllen'sJockstrap]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

At least, this is the case with my current plan.

Yeah, but you don't pay taxes on the loan, so other than the interest this is a wash.

Yes you do. Let's say you saved up 10K in your 401k using pre-tax contributions. If you take it all out a 10K loan (forget the interest for this purposes), the money you pay off that 10K is post tax. Depending on your tax bracket, that could be up to 35%. So to just pay the principal 10K you contributed 10K to get in your 401K, it could cost you 13.5K pre-tax to get to 10K post tax. Then, let's say you never touch that mooney again. You hit retirement age and withdrawl the full 10K. At the end of the year, you'll have to pay taxes on what's considered income. You're still in the same tax bracket and owe another 3.5K on the 10K you get when your 65 and empty your 401K. That may be a simplistic example, but your taxed on both events; when you take the loan, and when you withdrawl at retirement, because in both cases the 10K is considered a "contribution" to the account. And from the CNN.Money website:

When you eventually make withdrawals from a traditional defined contribution plan, you'll have to pay regular income taxes on the money you withdraw - whether the money came from your contributions, dividends or capital gains.

 

[uconnalum]

These are my own guidelines for borrowing against my 401K. I would borrow only to complete the funds for 20 % down on an investment property. Only would borrow an amount that can be repaid in under 12 months. Must maintain current contribution to 401K. With those guidelines I see it as a positive.

 

[Dragons]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

At least, this is the case with my current plan.

Yeah, but you don't pay taxes on the loan, so other than the interest this is a wash.

Yes you do. Let's say you saved up 10K in your 401k using pre-tax contributions. If you take it all out a 10K loan (forget the interest for this purposes), the money you pay off that 10K is post tax. Depending on your tax bracket, that could be up to 35%. So to just pay the principal 10K you contributed 10K to get in your 401K, it could cost you 13.5K pre-tax to get to 10K post tax. Then, let's say you never touch that mooney again. You hit retirement age and withdrawl the full 10K. At the end of the year, you'll have to pay taxes on what's considered income. You're still in the same tax bracket and owe another 3.5K on the 10K you get when your 65 and empty your 401K. That may be a simplistic example, but your taxed on both events; when you take the loan, and when you withdrawl at retirement, because in both cases the 10K is considered a "contribution" to the account. And from the CNN.Money website:

When you eventually make withdrawals from a traditional defined contribution plan, you'll have to pay regular income taxes on the money you withdraw - whether the money came from your contributions, dividends or capital gains.

I think this is made out to be much more than it actually is... Any other loan, except for a home mortgage loan, will be paid back with after tax dollars. Additionally, the money you're taking out has not yet been taxed (which I believe is the point Moe was trying to make). If you could put $100,000 into your 401k, take out a "loan for $50,000" without paying taxes and pay it back with pre-tax dollars, you have just taken a tax free distribution.

 

[Dragons]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains..

I don't think I understand your bolded point.

He is not making ~5% on the investment, he is making 0%. The money he pays back to himself can just be thought of as moving money from one pocket to another. One pocket will have more at the end and one will have less.

Yes, but the investment at the end of the term of the loan, will have grown at a 5% rate. If we're talking about missing out on market gains while the loan is withdrawn, it's not really a loss if you withdraw it from the fixed income portion of your 401k investment. Think of it as buying a 5% bond in yourself.

You have to decide for yourself how worthy you are of that investment.

 

[St. Louis Bob]

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.

Yep.

Just saw this too.

 

[NewlyRetired]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains..

I don't think I understand your bolded point.

He is not making ~5% on the investment, he is making 0%. The money he pays back to himself can just be thought of as moving money from one pocket to another. One pocket will have more at the end and one will have less.

Yes, but the investment at the end of the term of the loan, will have grown at a 5% rate. If we're talking about missing out on market gains while the loan is withdrawn, it's not really a loss if you withdraw it from the fixed income portion of your 401k investment. Think of it as buying a 5% bond in yourself.

I don't think I agree with the premise.

If he does not have to pay back the money to the 401k, he can invest that block of money in a brokerage account in similar investment vehicles and get the same return.

It is a wash. He is not coming out ahead by paying the money into the 401k vs moving the same amount of money to a brokerage account. You are still just moving money from one pocket to the next.

If you assume the investment vehicles are similar, your return will be very similar (this ignores the complicated tax situations of course).

 

[Dragons]

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?

I don't have the ability to check your math right now, but in premise it sounds correct. Also, factor in that you are paying yourself an interest rate (~5%) and you could treat that as your fixed income investment if you are worried about missing out on gains..

I don't think I understand your bolded point.He is not making ~5% on the investment, he is making 0%. The money he pays back to himself can just be thought of as moving money from one pocket to another. One pocket will have more at the end and one will have less.

Yes, but the investment at the end of the term of the loan, will have grown at a 5% rate. If we're talking about missing out on market gains while the loan is withdrawn, it's not really a loss if you withdraw it from the fixed income portion of your 401k investment. Think of it as buying a 5% bond in yourself.

I don't think I agree with the premise.If he does not have to pay back the money to the 401k, he can invest that block of money in a brokerage account in similar investment vehicles and get the same return.

It is a wash. He is not coming out ahead by paying the money into the 401k vs moving the same amount of money to a brokerage account. You are still just moving money from one pocket to the next.

If you assume the investment vehicles are similar, your return will be very similar (this ignores the complicated tax situations of course).

That is true if the decision is to borrow money from a 401k or do nothing. But in most cases that people consider 401k loans, they will be borrowing the money one way or another or in the case of the OP, replacing an existing loan. The payment will then not be available to invest in a similar vehicle in a brokerage account.

 

[parasaurolophus]

Another factor against the 401k loan is that you cannot repay the loan with pre-tax money. So if you borrow $50K, you're paying back $50K (plus interest) in after-tax dollars, which will be taxed again (along with the rest of the money) when it is withdrawn.

At least, this is the case with my current plan.

Yeah, but you don't pay taxes on the loan, so other than the interest this is a wash.

Yes you do. Let's say you saved up 10K in your 401k using pre-tax contributions. If you take it all out a 10K loan (forget the interest for this purposes), the money you pay off that 10K is post tax. Depending on your tax bracket, that could be up to 35%. So to just pay the principal 10K you contributed 10K to get in your 401K, it could cost you 13.5K pre-tax to get to 10K post tax. Then, let's say you never touch that mooney again. You hit retirement age and withdrawl the full 10K. At the end of the year, you'll have to pay taxes on what's considered income. You're still in the same tax bracket and owe another 3.5K on the 10K you get when your 65 and empty your 401K. That may be a simplistic example, but your taxed on both events; when you take the loan, and when you withdrawl at retirement, because in both cases the 10K is considered a "contribution" to the account. And from the CNN.Money website:

When you eventually make withdrawals from a traditional defined contribution plan, you'll have to pay regular income taxes on the money you withdraw - whether the money came from your contributions, dividends or capital gains.

When you repay a car loan you pay it back post tax. If you borrow from your 401k to pay off this loan and then pay it back post tax this is a wash.

Also when you make post tax contributions to your 401k you will only be taxed on the gains, not the original contribution. So the money that goes in for interest will not be double taxed.

 

[SHIZNITTTT]

Unless it is a medical emergency I can't see a reason to use your 401k.

 

[ghostguy123]

Sorry to bump this post (no I'm not), but a friend of a friend of an aquaintance or something is doing something like this:

Unable to get a bank loan for another year due to a foreclosure about 2 years ago that came after a bankruptcy like 5 years ago.

Looking at a house rigth at about $125,000 or $130,000.

They have roughly 80 grand in the bank, and can take a $50,000 loan out of their 401-k or 403-b or whatever it is and buy this house "cash" without a bank loan, but of course would have to re-pay the other loan in like 5 years or something like that.

Any reason to talk them out of this? I know they realize the risk of that money not gaining value since it won't be in their 401-k anymore, but they also will not have to pay rent for another year or more if they buy now.

 

[Nugget]

Sorry to bump this post (no I'm not), but a friend of a friend of an aquaintance or something is doing something like this:

Unable to get a bank loan for another year due to a foreclosure about 2 years ago that came after a bankruptcy like 5 years ago.

Looking at a house rigth at about $125,000 or $130,000.

They have roughly 80 grand in the bank, and can take a $50,000 loan out of their 401-k or 403-b or whatever it is and buy this house "cash" without a bank loan, but of course would have to re-pay the other loan in like 5 years or something like that.

Any reason to talk them out of this? I know they realize the risk of that money not gaining value since it won't be in their 401-k anymore, but they also will not have to pay rent for another year or more if they buy now.

This makes sense to me. They may also have up to 10 years on payback due to the home aspect.

 

[wilked]

Sorry to bump this post (no I'm not), but a friend of a friend of an aquaintance or something is doing something like this:

Unable to get a bank loan for another year due to a foreclosure about 2 years ago that came after a bankruptcy like 5 years ago.

Looking at a house rigth at about $125,000 or $130,000.

They have roughly 80 grand in the bank, and can take a $50,000 loan out of their 401-k or 403-b or whatever it is and buy this house "cash" without a bank loan, but of course would have to re-pay the other loan in like 5 years or something like that.

Any reason to talk them out of this? I know they realize the risk of that money not gaining value since it won't be in their 401-k anymore, but they also will not have to pay rent for another year or more if they buy now.

there are two main reasons not to do it.

One is a recent foreclosure, another is a recent bankruptcy.

As I said before, when you are borrowing from your 401k you are not borrowing from the bank managing your retirement money. You are borrowing from your future wheelchair bound old self. I can promise you that my future swearing at will, scotch drinking old self would not be comfortable lending my retirement dollars to a guy with those credit events on his recent resume.

They saved 80, while I am sure the place is a once in a lifetime deal (probably just like those last two places they owned) I encourage them to save the other 50 the old fashioned way

 

[gadkins]

Sorry to bump this post (no I'm not), but a friend of a friend of an aquaintance or something is doing something like this:

Unable to get a bank loan for another year due to a foreclosure about 2 years ago that came after a bankruptcy like 5 years ago.

Looking at a house rigth at about $125,000 or $130,000.

They have roughly 80 grand in the bank, and can take a $50,000 loan out of their 401-k or 403-b or whatever it is and buy this house "cash" without a bank loan, but of course would have to re-pay the other loan in like 5 years or something like that.

Any reason to talk them out of this? I know they realize the risk of that money not gaining value since it won't be in their 401-k anymore, but they also will not have to pay rent for another year or more if they buy now.

there are two main reasons not to do it.

One is a recent foreclosure, another is a recent bankruptcy.

As I said before, when you are borrowing from your 401k you are not borrowing from the bank managing your retirement money. You are borrowing from your future wheelchair bound old self. I can promise you that my future swearing at will, scotch drinking old self would not be comfortable lending my retirement dollars to a guy with those credit events on his recent resume.

They saved 80, while I am sure the place is a once in a lifetime deal (probably just like those last two places they owned) I encourage them to save the other 50 the old fashioned way

Good advice here!!! If you can't save it the old fashion way, they probably can't afford the house.

 

[jon_mx]

Sorry to bump this post (no I'm not), but a friend of a friend of an aquaintance or something is doing something like this:

Unable to get a bank loan for another year due to a foreclosure about 2 years ago that came after a bankruptcy like 5 years ago.

Looking at a house rigth at about $125,000 or $130,000.

They have roughly 80 grand in the bank, and can take a $50,000 loan out of their 401-k or 403-b or whatever it is and buy this house "cash" without a bank loan, but of course would have to re-pay the other loan in like 5 years or something like that.

Any reason to talk them out of this? I know they realize the risk of that money not gaining value since it won't be in their 401-k anymore, but they also will not have to pay rent for another year or more if they buy now.

there are two main reasons not to do it.

One is a recent foreclosure, another is a recent bankruptcy.

As I said before, when you are borrowing from your 401k you are not borrowing from the bank managing your retirement money. You are borrowing from your future wheelchair bound old self. I can promise you that my future swearing at will, scotch drinking old self would not be comfortable lending my retirement dollars to a guy with those credit events on his recent resume.

They saved 80, while I am sure the place is a once in a lifetime deal (probably just like those last two places they owned) I encourage them to save the other 50 the old fashioned way

Good advice here!!! If you can't save it the old fashion way, they probably can't afford the house.

The people who pay cash for their house are a tiny minority. Having $80K in savings just 5 years after bankruptcy is pretty good. I would guess they have very good income and perhaps a decent nest egg in their 401K. A $130K house seems well within their means. What would worry me the most is the foreclosure after the bankruptcy. If that bank which foreclosed has a judgement against them, it could easily attach it to the new house and put a lien on the house and then force another foreclosure unless they paid off the judgement. They will not be able to file bankruptcy again for several years and could get into a pickle.

ETA: It does raise some questions if they were able to save so much money, why weren't they making payments on their property which foreclosed? I assume they were upside down, but this makes little sense why they still owned that property after the bankruptcy. They should have let it go then.

 

[wilked]

jon, foreclosures can take a long time. During that time people can put a lot of money (free rent!) into their pocket

 

[ghostguy123]

They filed bankruptcy. The house was part of it but it took forever for them to foreclose on it.

Oh, with their incomes they could afford much more than a 130k house. Both are registered nurses.

They just cant get any sort of bank loan until after three years after the foreclosure, which was like 2 years ago, maybe a bit less.

This question I am asking has NOTHING to do with whether or not it is a good decision based on their financial standing and ability to repay it. They are as secure in their jobs as anyone could be these days.

I am talking strictly numbers. It seems much better to take out the 50k than pay an extra 10 grand for rent, and then repay the 50k within 4-5 years which they easily can and will.

 

[wilked]

This question I am asking has NOTHING to do with whether or not it is a good decision based on their financial standing and ability to repay it.

I am talking strictly numbers.

??

Sounds like you have already justified it in your mind. You are asking strangers to give an opinion on whether a couple who were recently bankrupted and foreclosed on if they should now borrow against their retirement. It is no surprise that we share a similar opinion to the loan officers they approached.

 

[jon_mx]

They filed bankruptcy. The house was part of it but it took forever for them to foreclose on it.

Oh, with their incomes they could afford much more than a 130k house. Both are registered nurses.

They just cant get any sort of bank loan until after three years after the foreclosure, which was like 2 years ago, maybe a bit less.

This question I am asking has NOTHING to do with whether or not it is a good decision based on their financial standing and ability to repay it. They are as secure in their jobs as anyone could be these days.

I am talking strictly numbers. It seems much better to take out the 50k than pay an extra 10 grand for rent, and then repay the 50k within 4-5 years which they easily can and will.

As long as the foreclosure debt was discharged in Bankruptcy, I think it makes perfect sense to buy the house. The numbers don't mean much to me. It is more of a lifestyle choice. Some people enjoy owning a home, having a property to work on.

 

[ghostguy123]

This question I am asking has NOTHING to do with whether or not it is a good decision based on their financial standing and ability to repay it.

I am talking strictly numbers.

??Sounds like you have already justified it in your mind. You are asking strangers to give an opinion on whether a couple who were recently bankrupted and foreclosed on if they should now borrow against their retirement. It is no surprise that we share a similar opinion to the loan officers they approached.

Justified???

I am asking if it makes financial sense assuming they repay the loan, which they will easily.

 

[ghostguy123]

Yes the house was discharged so they say.

And they are going to buy a house either now or next year. I am asking if it makes sense to buy now using 50k from the 401k and save 10 grand in rent, then repay the loan while still contributing to the 401k, likely contributing more in the long run since they save money on rent NOW, them contribute even more a few years from now since they won't have rent or a loan payment.

 

[lumpy19]

This question I am asking has NOTHING to do with whether or not it is a good decision based on their financial standing and ability to repay it.

I am talking strictly numbers.

??Sounds like you have already justified it in your mind. You are asking strangers to give an opinion on whether a couple who were recently bankrupted and foreclosed on if they should now borrow against their retirement. It is no surprise that we share a similar opinion to the loan officers they approached.

Justified???

I am asking if it makes financial sense assuming they repay the loan, which they will easily.

He answered the question on the first response and said no

 

[ghostguy123]

This question I am asking has NOTHING to do with whether or not it is a good decision based on their financial standing and ability to repay it.

I am talking strictly numbers.

??Sounds like you have already justified it in your mind. You are asking strangers to give an opinion on whether a couple who were recently bankrupted and foreclosed on if they should now borrow against their retirement. It is no surprise that we share a similar opinion to the loan officers they approached.

Justified???

I am asking if it makes financial sense assuming they repay the loan, which they will easily.

He answered the question on the first response and said no

Well, pretty sure a breakdown of the numbers shows it's a good move, unless somehow the market has a pretty large gain over the next 3 years or so, like a 20% gain.

10 grand rent saving in year one. 13 grand minus the 3 grand for property taxes. Other stuff for the house of course, but that is money that is going to go into it anyway. Call it 9 grand.

On a borrowed 50k, even a 20% increase in three years wouldn't be a full 10 grand since money is being repaid back into it that entire time.

Not to mention once this is repaid they are able to put a higher percentage of their pay into the 401-k.

Unless I am totally missing something, or unless the market make a ridiculous increase in this time span, I see no downside and only upside.

It seems most of the people here saying not to do it are using the idea that these people are irresponsible idiots and in theory should not borrow money ever for anything.................but not actually saying the numbers make it a bad move.

 

[Maelstrom]

You saying that even with an $80k downpayment, they can't get a $50k loan? That surprises me, seems like they could talk to a local credit union or somewhere that has a bit more flexibility than a bank. Now, it might be a bit higher interest rate, so they'd have to weigh that against the cost of taking out the 401K loan, but I really doubt they literally cannot get a loan.

 

[ghostguy123]

You saying that even with an $80k downpayment, they can't get a $50k loan? That surprises me, seems like they could talk to a local credit union or somewhere that has a bit more flexibility than a bank. Now, it might be a bit higher interest rate, so they'd have to weigh that against the cost of taking out the 401K loan, but I really doubt they literally cannot get a loan.

Nobody gives a home loan untili 3 years after a bankruptcy so they say....or should I say, 3 years after a foreclosure. In this case, the bankruptcy was filed and discharged (chapeter 7) wayyyy before they foreclosed on the house. It took them like 3 more years to foreclose on the house. Good thing in a way since they lived rent free and saved about an extra 30 grand. And yes, the foreclosure was part of the bankruptcy.

Now, yes I am sure there are some private lenders that will, for a much higher interest rate.

Depending on the rate it COULD be worth it, as long as the rate is comparable to normal rates, which I doubt they are.