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Borrowing from 401K
Old 05-08-2003, 06:21 PM   #1
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Borrowing from 401K

Hi All,
I would like to borrow from my 401K and pay up my mortgage($25K) and pay interest Prime plus 1%. I own my own corp and not in danger of loosing the job.I will repay to my 401K in 3 years. is it worth doing it?

Thanks
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Re: Borrowing from 401K
Old 05-09-2003, 12:13 AM   #2
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Re: Borrowing from 401K

Hi vjmed1, and welcome to this forum!

Don't know your whole story, but why not take advatage of all time low mortgage rates and just refinance your house, if you are not happy with your current rate? I doubt that rates in the neighborhood of 5% will be available forever.

Mikey
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Re: Borrowing from 401K
Old 05-09-2003, 01:51 PM   #3
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Re: Borrowing from 401K

The big thing (to me) with borrowing from the 401(k) is the opportunity cost. You presumably have invested that money with some thought, and for the period of the loan you're uninvesting a large portion of it.

When I was less financially responsible than I am now I took out half of my 401(k) as a loan to put a down payment on a house. When the house deal fell through I managed to squander (this is the irresponsible part) enough of the borrowed money away that I couldn't repay the loan, and my loan didn't allow partial repayments, so I wound up spending the rest, too. That 5-year loan period was during the largest bull market surge, and I missed out big-time.

And sure, when you borrow from it you pay yourself back with interest. But that interest is paid from taxed money, so your 'new contributions' from interest are post-tax.

Of course there are too many variables for me to give confident specific advice, but in my case every time I examine withdrawing or borrowing from my 401(k)s or IRAs it turns out to not be worth it. In fact, anything beyond cash transactions and straight financing (no fancy stuff) always seems to be less favorable to me when I examine it.

So a straight re-fi would be my uninformed first choice.

Oh, and if you can pay off your $25k 401(k) loan in 3 years I bet you could pay off a $25k straight refinancing in about the same time frame. So compare that payment size with your 401(k) versus a straight re-fi thoroughly and you should find your answer. Don't forget the opportunity cost!
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Re: Borrowing from 401K
Old 05-09-2003, 02:09 PM   #4
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Re: Borrowing from 401K

I've been tempted but never did it. In fact, when I
semiretired in 1993, I assumed I would have to start
drawing down my IRA right away (this money includes
my 401K from when I was last employed). Happily,
I have never had to touch it. However, I have had to assume some additional risk. I will be 59 and 1/2
in one year and if I get lucky, maybe I will be able to defer dipping into it even longer. If I absolutely had
to borrow, it would not be from my IRA, especially
with rates at historic lows.
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Re: Borrowing from 401K
Old 08-18-2003, 07:50 PM   #5
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Re: Borrowing from 401K

Borrowing from your future to live in the present is usually a poor idea. Consider that your 401k is capable of growing at double digit rates while a re-fi these days can be had for somewhere in the neighborhood of 5%. My wife and I just re-fi'd our home about a month and a half ago at 4.625% for a 15 year loan. This loan replaced a 30 year loan that we were 8 years into. Our house payments are about $15 a month less with the new loan and we have cut 7 years off of our payment schedule (22 years left on the old loan vs. 15 years on the new loan). We figure that this will save us about $96k. Compared to the loan costs of about $1600, this seems like a heck of a good return. Not mentioned in this saving is the possible investment return from that $96k, which over a period of several years could be substantial.

The bottom line is... yes, you CAN borrow from your 401k but you SHOULD NOT unless you are in dire financial straits with no reasonable alternative. You would be very hard pressed to find a competent financial advisor who would recommend borrowing from a 401k in most situations.

Ed_B
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Re: Borrowing from 401K
Old 08-19-2003, 01:26 AM   #6
 
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Re: Borrowing from 401K

I would think that borrowing from your 401k wouldn't have been a bad idea a year ago. The market certainly wasn't earning you any money so you might as well pay yourself 6%. This is assuming your 401k had relatively crappy fund choices and no option to buy actual bonds or other FI choices.
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Re: Borrowing from 401K
Old 08-19-2003, 07:06 AM   #7
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Re: Borrowing from 401K

Suggest you take look at the shadow. Use a etirement/or interest calculator and calulate now to when you plan to ER. Then rerun it three years later to see what kind of dent it will put in your ER plan.

P.S. fish camps don't have morgages-my co-worker borrowed from his 401k to remodel- he's still working- this was 1993. I.e. do the math to get a feel for the trade offs involved.
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Re: Borrowing from 401K
Old 08-20-2003, 08:24 AM   #8
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Re: Borrowing from 401K

I don't think it's going to be worthwhile to refinance such a small loan of $25k. The transaction costs will kill you unless you can "refinance" it with a no-cost HELOC or something like that.

If there were no taxes to consider, then it would make sence to just borrow from yourself, but I agree with BigMoneyJim that the taxes on your 401k withdrawls probably make this a poor choice. Unless you plan on being in a very low tax bracket when you withdraw the money you a going to be paying income tax on money that you contributued with after-tax dollars. It depends on your tax rate, and exactly what you would otherwise do with the money in your 401k.

Let's say your current loan is at 6% and you can invest in your 401k in a bond fund that yields 4%, you will pay back your loan at 4%, and your total (fed+state) tax rate is 33%, then I think you would be indifferent between keeping the mortgage and using the 401k money. If your current loan rate is higher you should pay off the mortgage. If your bond fund rate yield is higher, or your tax rate is higher, you should keep the mortgage.

Am I missing anything?
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Re: Borrowing from 401K
Old 09-06-2003, 09:23 PM   #9
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Re: Borrowing from 401K

>I would think that borrowing from your 401k wouldn't have been a bad idea a year ago. The market certainly wasn't
>earning you any money so you might as well pay yourself 6%. This is assuming your 401k had relatively crappy fund
>choices and no option to buy actual bonds or other FI choices.


Well, you can pick a time when just about any financial decision would have worked out OK. While you were paying yourself 6%, for example, a portfolio of REITS, high quality bonds, and small cap value funds would have paid you 12%. Oh, wait! I just used that famous 20-20 hind-sight to know what to do after the fact!

All kidding aside, most financial advisors do not recommend borrowing from a 401k unless the person involved is in a dire financial condition and has no other viable option. There are good reasons for this and most people who do borrow from their 401k plan regret having done it after the fact. Anyone who borrowed money from their 401k in 1995 can attest to the fact that they missed out on a huge run-up in stock prices in the 1996-2000 time period.

One thing not mentioned is that when you pay back a 401k loan, you use after tax money. This same money is then taxed again at your current income rate when it is withdrawn. The double taxation of this money takes a bite out of the amount that you have paid yourself. This is in addition to any gains that were not realized while your 401k balance was reduced by the amount of the loan.

I agree that too many 401k plans have poor or limited choices that make their earning potential a lot less than what could be achieved if a person had full control over how their money is invested. This is one reason why some companies have opted for a brokerage window option that allows complete investing freedom to any of their employees who choose to use it. Those who aren't interested in managing their money to this extent can still use the simpler approach of 10-12 standard investment choices.


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Re: Borrowing from 401K
Old 09-07-2003, 05:49 AM   #10
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Re: Borrowing from 401K

I'm not recommending this for everyone, but here's what I recently did.

My home is worth a couple hundred thousand and was paid up. But with mortgage rates so low, I figure that I can make a higher after-tax return by investing than I would pay on the mortgage.

I expect to be selling the house within a few years, so I took out a "hybrid" mortgage on about 2/3 the value of the house. It is a "hybrid" between a conventional adjustable rate mortgage and a fixed-term mortgage, in that the rate is guaranteed for a fixed period (3 years in my case) and then is subject to adjustment keyed to the prevailing interest rate. I got an interest rate of 4.00% (shortly after rates bottomed).

As Bongo2 pointed out, any such loan has transaction costs that should be considered, but when the loan is large enough, these tend to be minor as a percent of the loan amount.
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Re: Borrowing from 401K
Old 09-07-2003, 05:59 AM   #11
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Re: Borrowing from 401K

I'm not recommending this for everyone, but here's what I recently did.

My home is worth a couple hundred thousand and was paid up. But with mortgage rates so low, I figure that I can make a higher after-tax return by investing than I would pay on the mortgage.

I expect to be selling the house within a few years, so I took out a "hybrid" mortgage on about 2/3 the value of the house. It is a "hybrid" between a conventional adjustable rate mortgage and a fixed-term mortgage, in that the rate is guaranteed for a fixed period (3 years in my case) and then is subject to adjustment keyed to the prevailing interest rate. I got an interest rate of 4.00% (shortly after rates bottomed).

As Bongo2 pointed out, any such loan has transaction costs that should be considered, but when the loan is large enough, these tend to be minor as a percent of the loan amount. It works out that my "effective" rate is about 4.12%. But my after-tax rate will be less since the interest payments are deductible.

Of course, I don't have 20-20 foresight and am not certain that I can "beat" the 4.12% pre-tax return. But I think that I have an excellent chance by just investing most of it in Vanguard's and TIAA-CREF's high yield bond funds, which are less risky than most such funds and pay about 7%. Of course, if interest rates skyrocket, I could lose on the deal, but that's the nature of investment risk. There's no free lunch.
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Re: Borrowing from 401K
Old 09-07-2003, 03:49 PM   #12
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Re: Borrowing from 401K

I've been very tempted to borrow against our house
(owned free and clear) with rates so low, also figuring
I pick up a few dollars by investing elsewhere. Two things are holding me back. I am
very pro real estate (almost any kind) as part of a
diversified portfolio. Remember, I own no common
stocks. Although the money in real estate is illiquid,
this can be a positive in the sense that it keeps me from
easily accessing the money for other schemes (although
they are making it easier and easier to get the cash out).
Anyway, for anyone who cares, my present
allocation is:

Real estate 40%
Bond funds 11%
Investment grade bonds 11%
CDs 3%
Corporate Notes 20%
Cash 10%
Personal property 5%
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