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new slant on pay off mortgage question
Old 03-04-2012, 06:18 PM   #1
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new slant on pay off mortgage question

I am currently building a new home and have been paying cash as I go. I received some advice to take a loan from my 401k and pay myself back at about 6%. Apparently this is a legal rate (max rate) and strategy – any one have experience?
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Old 03-04-2012, 06:32 PM   #2
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We did this for our kitchen remodel. It was the right decision for us, but there are some caveats...
* Your loan payments include the interest you pay yourself, but unless you repurchase your shares at the same exact rate (which is almost impossible) your actual rate will vary. If the funds go up in price, you'll be earning less or losing money on the deal.
* If your employment is terminated by you or your employer, you must pay it back in full or any outstanding loan balance will be classified as a withdrawal and you'll be subject to income tax and penalties.
* Some plans allow for prepayment of the balance, and some do not. We wouldn't have done it if we couldn't pay it back as soon as construction was completed.
* In our plan some funds were excluded, so even if your plan allows loans you might currently be invested in funds that don't allow loans.
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Old 03-04-2012, 06:39 PM   #3
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In my opinion, 401k loans are not loans at all. Your plan will sell assets to produce the funds for the "loan".

If you can designate the loan proceeds come from the fixed income portion of your 401k, it locks your cost of funds. Even if your plan does not let you designate which funds to sell, you can achieve same results by rebalancing. If your plan sells stocks that go up in value while you are paying back the loan, the "lost opportunity" adds cost to your loan. This could work in your favor if the stocks go down in value.

The interest rate is really meaningless except it does help make up for the time those funds are out of the plan.

I don't t
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Old 03-04-2012, 09:20 PM   #4
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Quote:
Originally Posted by nphx View Post
I am currently building a new home and have been paying cash as I go. I received some advice to take a loan from my 401k and pay myself back at about 6%. Apparently this is a legal rate (max rate) and strategy – any one have experience?
The interest rate is set by the plan administrator... there is no maximum... however, it is supposed to be market

Quote:
Originally Posted by jennypenny View Post
We did this for our kitchen remodel. It was the right decision for us, but there are some caveats...
* Your loan payments include the interest you pay yourself, but unless you repurchase your shares at the same exact rate (which is almost impossible) your actual rate will vary. If the funds go up in price, you'll be earning less or losing money on the deal.
* If your employment is terminated by you or your employer, you must pay it back in full or any outstanding loan balance will be classified as a withdrawal and you'll be subject to income tax and penalties.
* Some plans allow for prepayment of the balance, and some do not. We wouldn't have done it if we couldn't pay it back as soon as construction was completed.
* In our plan some funds were excluded, so even if your plan allows loans you might currently be invested in funds that don't allow loans.

Not all plans require you to pay off a loan if you leave employment.... it is an option that the company chooses when setting up the plan... the plan that my company set up only requires that you pay it by the end of the year you leave...
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Old 03-05-2012, 08:13 AM   #5
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Thanks - our 401k adminstration is done privately but is in a fidelity account. It seems like if i had a 6% guaranteed investment i would do it so it seems to be a good decision.
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These 401K loans can be Extremely Expensive Money
Old 03-05-2012, 11:04 AM   #6
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These 401K loans can be Extremely Expensive Money

Besides foregoing the growth of the loan assets, the fees, and possible other "hidden" penalties...

Check out this article:

7 Reasons Why Borrowing From Your 401k is Bad, Bad, Bad!

Quote:
4 – You pay double taxes
While the loan itself isn’t taxed, remember you are paying the loan from payroll taxed dollars. Down the road when you pull out of your 401k, you will again have to pay taxes on that as well, so essentially any money you pay against the loan is really double taxed.
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Old 03-05-2012, 01:07 PM   #7
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Just to clarify, this double taxation only applies to the interest paid on the loan (which is not tax deductible). Clearly, there's no double taxation of the principal.
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Old 03-05-2012, 01:16 PM   #8
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What loans can you repay with pre-tax dollars?
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Old 03-06-2012, 03:45 PM   #9
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Originally Posted by nphx View Post
I am currently building a new home and have been paying cash as I go. I received some advice to take a loan from my 401k and pay myself back at about 6%. Apparently this is a legal rate (max rate) and strategy – any one have experience?
Yes. There are at least two downsides.

1) if you leave the company, you must pay the loan back immediately...OUCH.

2) There is an opportunity cost of not having the money in the account. If you do it and the market crashes, you look like a genius. If you do it and the market surges, you look like a dufus.

Good luck!
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