Borrowing against 401K- is it dumb?
Well - I have already done it but I am considering my options to fix this mistake.
Borrowed the money to make a 20% down payment on a house a year ago. I currently owe 33,000 back to the 401k (originally borrowed 42,000). I am paying this at 9.5%. This is interest that I am paying back to myself.
Would it be better to open a credit line at basically prime (have offers from several lenders) with no fees. Call prime 8.25%. Now this would be tax deductible. So what is that an effective rate of 6%?
This is where I get stuck. What's the better option? Borrow on a credit line and pay off the 401k loan or let it stay as is? Help...
- 1 decade agoFavorite Answer
I wouldn't say it was dumb but it does depend on some facts.
We borrowed against our 401k for our down payment 7 months ago. At 8%, it was a better option than to take out a second and we are really borrowing from ourselves. Should one of us lose our job, it would be paid out of our 401k stocks and that would be covered.
Now, we bought a house that was seriously undervalued (a previous owner had been murdered in it) so right away we gain equity. We will wait about five years, then refinance to pay off the 401k. We are also paying off the morgage at with appx 5% on top of the morgage every month to pay down the principle.
I have a feeling that the prime that you are talking about is an adjustable? Don't do an adjustable, EVER!
- Bulk OLv 51 decade ago
Yeah it is dumb, been there, done that. First off I ended up quiting the job and having to take the money out of my 401K with penaty, but even if you don't you are going to be using after tax money to repay this, and when you retire you are going end paying tax and that amount again.
On your actual question. You don't provide enough information to tell. People say something like it is tax deductable and everyone jumps at 33% is what it will be lowered by, but that isn't true. If you deduct something it simply means that your income goes done by that much. If say you made $11,000, and could deduct $1,000 then your taxes are reduced by $1000 x what you pay in taxes, but if you are say in the "33% tax bracket" you are not paying 33%, because we have a system where the first X dollars aren't taxed, then the next tax bracket is tax at a lower percent then 33%, and on up to finally only some of you money is actually taxed at 33%. So you really need to know your effective tax rate which is approximately the tax you actually paid last year divided by your total income. That might be more like 15-20% and that is the number you need to reduce interest by to see what the real after tax rate is.
Also there is the effect of not having the money in the 401K. If your investments are doing better then the 9.5% minus the tax you are paying, then you are losing that money too, not just the difference between the two interest rates.
Of course if your investments in your 401K suck, maybe you paying yourself even after the taxes might be better.
- 1 decade ago
Dont beat yourself up on this. You did the right thing. Dont take out any loans to repay the 401K. I dont know your age, which would be somewhat a factor in my answer but I assume you are still pretty young. (under 45) You still have 20 years to work on repaying and building your 401K up. The 20% you put down on your house offsets whatever you think your losing on your 401K. No PMI, better interest rates, hopefully maybe a shorter term but most importantly getting a payment that you can more than likely afford every month. You are looking at what that 20% would be doing in your 401K, not what it saved you. Your house must have been around 200K. With you putting that 40K down you are saving close to $240 per month on your mortgage. Not bad. Now take that $240 extra your saving and apply it to any credit cards or other debts to get them paid off early. Now that 40K is really working for you now. Good Luck 2 U
- 4 years ago
Please look elsewhere for the money. I do not believe there is a stipulation on borrowing (again) but it is a bad financial move. Joe Schmuch you work with will say what a great deal it is "pay yourself the interest". Don't buy it. You are losing the ''compounding interest'' by taking from the total balance and reducing it. If you leave your job and have to rollover the 401k you will have 90 days (I think) to pay it back or you have to claim it as income and pay an additional 10% penalty. 25% to 48% potential loss, not me. Good luck.
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- Feeling MutualLv 71 decade ago
If you change jobs, or lose your job, the loan is immediately called and has to be paid back right away.
A 401K is a tax deferred account. The 9.5% interest that you pay on it, is not tax deferred, therefore you pay tax on that 9.5% twice.
A 2nd mortgage would be a better idea to pay it back. That way the interest is tax deductable. Interest on a credit line is not tax deductable.
- Anonymous1 decade ago
I wouldn't call it dumb - its not a smart thing to do in this economy. But since you've already borrowed the money @ 9.5% it would be better to transfer the the 33k to the line of credit @ 8.25% that the banks are extending to you. But try to get the line of credit at lower % . But at any rate It would lower your payment plus it will give you a deduction at tax time - that may bring you a return of 3% - 5%.