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HighHeat
Big Daddy
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Joined: 30 May 2004
Posts: 6682
Location: Out of the frying pan, and into the fire.
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 Posted: 02/02/05 - 21:33 Post subject: Borrowing against a 401k
Does anyone have any opinions one way or the other about borrowing against a 401k to pay down consumer debt?
From what little I know about the borrowing set up, you simply pay back the borrowed amount via your regular 401k contribution. There's no penalty, because I wouldn't be cashing out a portion of the fund, just taking a loan out against it.
I'm thinking I'd like to borrow to pay off the last credit card we have, and the car, so we'd be debt-free besides my student loans. The money we save on a monthly basis would allow us to max out on our 401k contribution and kick even more into our savings.
Is my logic flawed on this?
Thanks in advance...
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jrjo
Gone Fishin
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Joined: 15 May 2002
Posts: 16451
Location: Lake Wobegon, MN
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Posted: 02/02/05 - 23:51 Post subject:
The hinge factor is what kind of rate has/will your 401k make for you. That versus the interest rates on the debt.
For instance, you're pulling down 8% growth in the 401 and paying 14% on the card and 10% on the car. Slam dunk, go for the 401 loan and get rid of the loans. Second scenario, you're making 11% growth on the 401 and paying 10% on the card and 8% on the car loan. In this case, leave the money in the 401, you'll be money ahead.
I know it's tempting to have some peace of mind with being car and credit card loan free. But unless you have some real dog funds in your 401, I expect you're making good returns there and your money will work for you better if you find some other ways to get the debt rates down.
Can you refi the car loan? I would expect so. Maybe get that down to 5 or 6%. And do you own a home? A home equity credit line is the way to go and get that credit card gone. That way too, you can deduct the interest if you itemize and typically have a federal income tax liability.
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Ms. Jenn
Fresh, Hot & Wild
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Joined: 14 Feb 2004
Posts: 7935
Location: Suite 550
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Posted: 02/03/05 - 07:03 Post subject:
With most 401 (k) loans you are not allowed to borrow more than 50% of your vested interest. You're last statement will show your total balance and your vested balance. If your vested balance is $17K, you can only borrow up to $8500, and there will be a loan processing fee taken out of the $8500 leaving you with a loan of ~$8250.
Your employer gets to set the interest rate you pay on the amount you loaned yourself. Could be low...3%, could be high 10%. Since I was the 401(k) distributor at my office, our interest rates were 2.5% because most people are trying to use this loan to get out of other high interest debt. The 401(k) company will set your loan payment amount.
Once you take a loan from your 401(k), you cannot borrow from it again until a year after the first loan is paid back (this restriction varies from plan to plan though, but they're all about the same).
Another problem, I couldn't afford the loan payment and my monthly 10% contribution so I had to quit contributing to pay my loan payment. The no contribution/only loan payment isn't beneficial for everyone, but it kept more delinquent medical bills off my credit report and out of small claims court (i.e. we didn't have the money to pay them if I hadn't taken this loan out).
The loan payment was less than my monthly 10% contribution so we gained a few bucks a week and released the stress of bad debt.
If you only have enough money to borrow to pay off the credit cards or the car loan, I'd choose the credit cards. Higher interest, more negative on a credit report, unless of course your late on your car loan. If you're late on your car loan, catch yourself up, pay down the balance and refinance it to a more affordable monthly payment.
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copteacher
Adjunct
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Joined: 08 Jun 2002
Posts: 20588
Location: Teaching in the Halls of Justice
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Posted: 02/03/05 - 07:12 Post subject:
remember you are paying yourself back so the faster it is paid back the more interest you make. Generally it is pretty good for a short term but pay it back quick because you are costing yourself money
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brie k
Member
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Joined: 15 May 2002
Posts: 5661
Location: where the wild things are
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Posted: 02/03/05 - 08:55 Post subject:
We did this to pay off credit card debt, and you can only take out 50% for that. To buy your first home, however, you can take all of it.
Do it, but then put the cards away so you don't get back into the habit. We didn't do that. I've learned my lesson now though, and while I have 2 major credit cards and a couple of store credit cards, I only spend what I can afford. I try to use the American Express too, because I know I have to pay that off. Keeps me honest. 
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