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Debt Paydown Question
Old 06-30-2006, 07:18 PM   #1
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Debt Paydown Question

Hi everyone. I found this message board recently, and I've learned a lot from reading here. I was hoping I could get some advice for a question I have.

I currently have $10,000 in savings that I am using for debt repayment. However, I have a couple debts I need to pay off, and I'm wondering which to try to pay off first.

My first debt is a 401k loan. I owe $7,000. The interest rate is 6.25%.
My second debt is a personal student loan. I owe about $11,000 at an 11.5% interest rate. Another month or two of saving should allow me to pay this off.

What would you pay off first and why?

Chris
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Re: Debt Paydown Question
Old 06-30-2006, 07:45 PM   #2
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Re: Debt Paydown Question

Chris, welcome to the forum.

First, congratulations on being in a situation where you can pay off a loan.

Conventional wisdom says pay off the higher interest rate first of course, but have you considered what the 401(k) loan is really costing you? Not only are you paying 6.25% interest, you are losing the investment opportuninty of than money as well. If you conservatively assume you could earn 5% on that money (MMkt accounts are paying in that range), your actual borrowing cost would be 11.25%.

Maybe the real answer is you can't really go wrong either way...

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Re: Debt Paydown Question
Old 06-30-2006, 07:53 PM   #3
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Re: Debt Paydown Question

Your post makes it sound like you're waiting until you have the total amount to pay the debt off. You said that you have 10,000 in savings and in another month or two of saving, should be able to pay it off. Not sure if that's what you meant, but that's what it sounded like.
Don't wait - put the 10,000 on the higher rate loan first, and pay as you go.
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Re: Debt Paydown Question
Old 06-30-2006, 08:42 PM   #4
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Re: Debt Paydown Question

Pay the debt with the highest interest rate first and then your 401k plan. I would definitely utilize some of the money you have on savings to pay your debt off, but I will keep some money on savings for any emergency.
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Re: Debt Paydown Question
Old 06-30-2006, 09:33 PM   #5
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Re: Debt Paydown Question

Just a reminder that if you lose your job, you will only have a short time (90 days?) to repay that 401K loan. So consider your job situation in making this decision.
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Re: Debt Paydown Question
Old 07-01-2006, 04:12 AM   #6
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Re: Debt Paydown Question

I figure I'll throw my thoughts out here. Since you are unable to completely pay off the student loan, I'd pay off the 401 loan then put the leftover savings and the now freed up 401 payment, in addition to the student loan payment, toward the student loan.
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Re: Debt Paydown Question
Old 07-01-2006, 10:33 AM   #7
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Re: Debt Paydown Question

One negative about taking a loan on 401(k) is also a positive about repaying it first. Hope that makes sense.

When you take a loan from a 401(K), not only do you take that money out of your retirement savings and lower your long-term return, but you receive a loan from funds that have not paid taxes (tax deferred) however you repay the loan with funds that you have already paid taxes on (taxable). When you later take the funds for your use when you are retired, you pay taxes again on the same funds. This flaw in the process is seldom taken into account by the person borrowing the 401(k) funds from "himself".

Asd I see it, the sooner that you repay the 401(k) loan the better off you will be in the long run.
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Re: Debt Paydown Question
Old 07-02-2006, 01:06 AM   #8
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Re: Debt Paydown Question

Why not see about changing the rate on the school loan . I would call them first and see if they can get you a better rate. Then look around.
I have credit cards I can borrow from and get a better rate then that loan. You should be able to either do that or find somene to refinace it at a better rate.
Not all 401k's are equal. With mine I would be able to continue to make payments if I lost the job. Your paying yourself back so you are making some money on the amount you have removed from the loan. As far as double taxation its only on the interest. You receive the borrowed funds tax free and then pay back with the same tax free money plus interest. That interest is then taxed again while any earnings in the 401k are not taxed until they are removed.
I also think it might be easier to make more money on the money outside the 401k. In my opinion the 401k choices are too limited.

www.bankrate.com is a good place for checking out loan/credit card options
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Re: Debt Paydown Question
Old 07-02-2006, 01:16 AM   #9
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Re: Debt Paydown Question

Quote:
Originally Posted by spideyrdpd
Your paying yourself back so you are making some money on the amount you have removed from the loan.
If that's the case then you should charge yourself 200% interest...
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Re: Debt Paydown Question
Old 07-02-2006, 03:55 PM   #10
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Re: Debt Paydown Question

I would recommend stashing a couple of month’s salary away as an emergency fund.* You can gradually build this up to three or better still six months worth of salary.* Having an emergency fund can keep you from borrowing against your 401k in the future and can keep you from using credit cards when your in a jam.

Now look at your debt. You are making payments on both of them.* Look at how much you are paying on each.* *It is best to be systematic with debt reduction.* Choose one, your choice. Put any extra money you have left after establishing your emergency fund towards paying off one of the debts.* Keep up the minimum payment on the remaining one.* Once you have paid off the first debt take the money you used to get rid of it and add it towards paying off the remaining debt.
When I did a rapid debt reduction plan I started with the debt with the lowest balance.* It gave me a nice psychological boost to see that balance hit zero.* * Then I worked on the next one. DH and I cleared* $35,000 in debt in a year and a half doing this.

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Re: Debt Paydown Question
Old 07-02-2006, 05:04 PM   #11
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Re: Debt Paydown Question

Quote:
Originally Posted by Nords
If that's the case then you should charge yourself 200% interest...
Cause then I would be really really broke

I am not sure if your serious or just busting my chops....

But the next guy also didnt discuss it like it was money from a 401k.
So maybe people just are not familar with the 401k. My company plan is with fidelity. I can click on my account and they tell me how much I can borrow and at what rate. The present rate is about 9% . So its not that far from the 11% the other guy expects to receive in his 401k. Many people put money into the fixed account before I slap advise them and make them buy something else. Of course they are no where no retiring and need to get a return thats better than 2% .
Of course many of my co workers borrow money to buy doodads err very important things they cant live without.

So my answer wouldnt change much. Invest the 10k and pay back the debts via your income. Many people couldnt put together 10k without jumping infront of a car. You know have a small chunk of change that could plant a very nice money tree.
Again I would work to see if I could get the rate on the student loan lowered. Or call my credit card company and see if they will send me a check that would have a lower rate....
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Re: Debt Paydown Question
Old 07-03-2006, 08:31 AM   #12
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Re: Debt Paydown Question

A simpler way to think about your 401k loan is that it is the same thing as if you had invested $7,000 of your 401K funds in a bond paying 6.25% while simultaneously getting a consumer loan outside of your 401k for $7,000 at a 6.25% interest rate.
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