: Should I temporarily stop or decrease 401k investment to pay off a loan? I have a loan with a 9% annual interest rate compounded monthly with about 50 left on it. My minimum monthly payment is 6, which is all I've been

Vote Up Vote Down   0 Reactions

Login to give Reaction!

Three Options:

Carry on with current 401k contribution and loan repayment (0 to 401k, 6 to loan).
Stop 401k contributions and focus on loan (6 to loan).
Take out a 401k loan to pay off the loan immediately, then repay 401k loan. (6 to 401k loan).

401k Loans
A 401k loan has an interest rate (~5% today), but that loan interest gets paid back into your 401k account. The down-side of a 401k loan is that you miss out on potential gains by reducing your 401k balance. There's also a small amount of double-taxation on the interest you pay yourself, since it's paid with after-tax dollars, for example if you get a ,050 401k loan at 5% and are in the 20% income tax bracket, paying back your full 6/month you'd pay ~ in extra tax over the course of your 401k loan, not a huge amount, but worth noting. Also, if you leave your current company before repayment is finished, you have a limited amount of time to finish repayment in full, or the outstanding balance of the loan gets treated as a distribution subject to the 10% early withdrawal penalty.

With a 401k loan you save on paying your loan interest from day 1, and you start rebuilding your 401k balance with your first payment. A 401k loan is most attractive when it's short term and it enables you to avoid paying a high interest rate.

Option Comparison
I looked at all 3 options above using a range of 401k return rates (0-20%). Assuming that in each scenario the full amount goes to your 401k after loan repayment is done. The result is that a 401k loan beats the others unless your 401k returns at above 9%, at which point it is better to just keep on with current payments. The difference between the options is pretty insignificant if your 401k returns near 9%, even if it dipped to 0% you'd only save ~0 by going with a 401k loan.

My Answer
I wouldn't count on a 401k sustaining > 9% growth, and because reduced debt gives you increased flexibility and may help you avoid future debt, paying off the loan early seems best. While a 401k loan could come out ahead of just putting 6 to your loan each month, it wouldn't save you that much money even in the worst case scenario, and would cost you a little bit if 401k returns stay high. I would be tempted to borrow from my 401k because I'm curious to find out how easy the process is, but if I thought there was a chance my employment situation would change in the near future, I'd avoid the 401k loan, temporarily stop contributing and pay the debt down quickly.

Here's a good article on 401k loans: Sometimes It Pays to Borrow from Your 401(k)

Vote Up Vote Down   0 Reactions

Login to give Reaction!

My employer doesn't do any matching.

As soon as I read this statement, my thought was that, yes, you should stop investing for retirement that is years away and pay off these loans that are causing pain now. Your 12% return isn't guaranteed forever, and often will be less that the 9% you're paying in interest.

I would not stop at this loan, though. I would attack the car loan next, taking your retirement and other loan payment and putting another 0 a month on it. Hopefully that will get your loan paid off quickly, unless you have a ridiculously high car loan, in which case I would consider moving down in car until you are in a better financial position.