topic Re: A General 401k/Loan Repayment Finances Question in General Credit Topics

A General 401k/Loan Repayment Finances Question

neverrain — Fri, 13 Apr 2012 19:20:32 GMT

So I have been reading that there is slightly more importance placed on paying off student loans (in good standing). Currently, here is where I am. I need to make a decision on this today so I ca make the change to my 401k if needed.

1. Currently contributing 8% of my paycheck to my 401k. My company matches 4%.

2. Remaining DoE loan is at about ~$10k @ 2.5% interest. Currently making $80 payments a month.

If I remove my contribution temporarily to my 401k, I can get close to $1k/month payments on the loan and have it gone in about a year. I looked into it an the annual return rate on my 401k is just under 5% (which seems low to me).

Is it smart financially to hold off on my 401k for about a year to pay down and remove this loan?

In case it matter, I am 31 years old. I realize at 50 it may be a worse idea.

Re: A General 401k/Loan Repayment Finances Question

Revelate — Fri, 13 Apr 2012 19:40:37 GMT

No, paying off an installment loan isn't a huge factor except for DTI calculations on a mortgage or auto loan.

Keep contributing to that 401K, that annual rate of return is compounded, so money you put in now, counts for quite a bit more than money you put in 10 years from now. Never give up a long-term benefit for short-term satisfaction financially, and arguably you may be doing yourself more harm even from a FICO perspective within the next decade by paying that student loan off early. I'm not seeing really any short-term upside other than pride/emotional benefit of getting it paid off. So you'll be there in 1.5 or 2 years instead of 1, it doesn't matter rationally.

Re: A General 401k/Loan Repayment Finances Question

neverrain — Fri, 13 Apr 2012 19:48:52 GMT

What kind of harm are you referring to on the FICO standpoint?

Also, I was considering only matching up to 4% and placing the other 4% into another investment. Maybe a Roth IRA or some type of investment account?

Re: A General 401k/Loan Repayment Finances Question

Revelate — Fri, 13 Apr 2012 20:01:25 GMT

neverrain wrote:
What kind of harm are you referring to on the FICO standpoint?

Also, I was considering only matching up to 4% and placing the other 4% into another investment. Maybe a Roth IRA or some type of investment account?

Roth IRA vs. 401K is mostly a question of whether you think you'll be making more money after you start taking distributions from your 401K / Roth IRA, or less. If you're going to be in a lower tax bracket, 401K makes more sense; however, if you're going to be a higher one, Roth does. There's some additional things which are a *lot* more complicated (such as what you can do with a 401K vs. a Roth IRA) but that's the basics of it as 401K contributions are pre-tax (and incidently lower your current tax burden, which might be huge if you're at a bracket border under the current tax code), and Roth IRA ones are post-tax.

I can't give better advice than that without a lot more data points, and I'm not an expert anyway.

The harm is simply this, and it's minor: the longer your installment loans tick out, the better that looks for your AAoA as far as the FICO algoritm is concerned... and there's a lot of anecdotal evidence on this forum which suggests that paying off an installment loan is a small benefit if any from a score perspective. Anyway, AAoA issues might be minor damage, but it's there... whereas paying off is probably score neutral, so I consider that to be harming one's score. Don't know where you're at but it would truly suck for me if I hit 639 on a mortgage application someday, so I play for maximization over a longer time-horizon and others will probably offer different opinions.

Re: A General 401k/Loan Repayment Finances Question

neverrain — Fri, 13 Apr 2012 20:14:53 GMT

Yea that makes sense regarding the FICO thing. The account has really only been open for about a year anyway. I think my intention would be more for just having one less thing to worry about.

Thanks for the inut.

Re: A General 401k/Loan Repayment Finances Question

cassembler — Fri, 13 Apr 2012 22:00:31 GMT

When you say they match 4%, is it 50% of up to 4%?

Regardless, I would ALWAYS put in up to what the company matches. Iit's an INSTANT 50% return on invetsment*, and nothing else can match that rate of return!!!!!

(*you have to factor in vesting, of course, if you plan on leaving or getting fired...)

After that, I'm a fan of paying off anything that has a high interest rate next, usually credit cards. Then, I agree with Revelate that there's no hurry to pay down the loans. 5% return isn't awful, but consider that will be componded over the next 35 years... The student loans will be paid off within a few.

Re: A General 401k/Loan Repayment Finances Question

AndySoCal — Fri, 13 Apr 2012 22:00:36 GMT

I would not change the 401K contribution. Your student loan interest rate is lower than your 401K rate of return on investments.

Re: A General 401k/Loan Repayment Finances Question

neverrain — Fri, 13 Apr 2012 22:08:04 GMT

My company matches 100% up to 4% of my paycheck I guess is another way of saying it.

Aside from just paying down the loans and getting rid of them, I still need to build up an emergency fund for at least 3 months. I have no real credit card debt to worry about, it's mostly paid in full every month. I just want to be debt free completly so I can save and buy toys when I feel inclned.

Re: A General 401k/Loan Repayment Finances Question

cassembler — Fri, 13 Apr 2012 22:55:26 GMT

neverrain wrote:
My company matches 100% up to 4% of my paycheck I guess is another way of saying it.

Aside from just paying down the loans and getting rid of them, I still need to build up an emergency fund for at least 3 months. I have no real credit card debt to worry about, it's mostly paid in full every month. I just want to be debt free completly so I can save and buy toys when I feel inclned.

100% of 4% is a sweet deal, I'm very jealous! I would make sure it's not 50% of 8% though, there is a difference.

As for the emergency fund vs student loans vs 401k, etc... At your age (and my age), I think savings tend to be over-emphasized in importance. I'm not saying it's not important, but I will say that equally important is managing revolving credit. I think of revolving credit purely as a cash flow tool, meaning if you go though a few months with reduced (or zero) income, or higher expenses, you can re-allocate that gap across the following months.

Basically, I'd consider available revolving credit as a part (A part) of your savings, if that makes sense. You actual liquid savings is ideally enough to cover all of your installments and revolving minimum payments (plus rent, etc), but at ~30 I wouldn't say you must have 3 or 6 months of net income saved.

Family + spouse + house alters the equation, of course.

Re: A General 401k/Loan Repayment Finances Question

neverrain — Fri, 13 Apr 2012 23:09:30 GMT

I'm sure it is 100% of 4%. At the moment, the 8% I am putting in works to a little over $400/month, and I can see the $200ish they put in. Yea, I know it's a pretty sweet deal.

As for the emergency fund, I was figuring enough to cover all our bills (I live with my gf) in full for 3-6 month. I would rather stay away from credit cards unless absolutely necessary. Between the 2 of us we probably have close to 20k in available credit, but rent and utilities can't be paid with that, so liquid cash is more preferable to me for an emergency fund. I guess YMMV applies here.

Re: A General 401k/Loan Repayment Finances Question

cassembler — Fri, 13 Apr 2012 23:21:41 GMT

neverrain wrote:
I'm sure it is 100% of 4%. At the moment, the 8% I am putting in works to a little over $400/month, and I can see the $200ish they put in. Yea, I know it's a pretty sweet deal.

As for the emergency fund, I was figuring enough to cover all our bills (I live with my gf) in full for 3-6 month. I would rather stay away from credit cards unless absolutely necessary. Between the 2 of us we probably have close to 20k in available credit, but rent and utilities can't be paid with that, so liquid cash is more preferable to me for an emergency fund. I guess YMMV applies here.

Point absolutely taken, and that's a wise decision. I'm only suggesting that 20k in available credit will definitely come in handy should one of you lose employment, and may affect how much you're comfortable with saving for a nest egg - especially if you're also saving for something specifc (house, car, etc).

Side note, I pay utilities all the time with a card and PIF:) Rewards, baby!

Re: A General 401k/Loan Repayment Finances Question

neverrain — Fri, 13 Apr 2012 23:30:58 GMT

I wish I could too. My Utilities (SoCalGas) and the LADWP dont allow it. Only checking transfers. (That I'm aware of)

Re: A General 401k/Loan Repayment Finances Question

SanFranMatt — Mon, 16 Apr 2012 19:14:05 GMT

Student Loans are generally tax deductible, so your effective rate is under 2%. I'd pay the absolute minimum and stretch out the payments as long as possible, because you can't take out a loan that cheap. Even if you have an extra $10K laying around so that you can pay it off immediately, I'd still recommend paying the minimum. If something bad happens and you lose your job or have an emergency, you'd really regret overpaying the student loans.

I'm a year older than you and I have about $6K left in loans, at about the same interest rate as you. I paid off about $5K of my loans when I first left school. Now I wish I didn't. I'm looking to buy a house soon, and I'd much rather have that extra $5K for a down payment or emergency fund.

Re: A General 401k/Loan Repayment Finances Question

oracles — Mon, 16 Apr 2012 20:12:43 GMT

Revelate wrote:
No, paying off an installment loan isn't a huge factor except for DTI calculations on a mortgage or auto loan.

Keep contributing to that 401K, that annual rate of return is compounded, so money you put in now, counts for quite a bit more than money you put in 10 years from now. Never give up a long-term benefit for short-term satisfaction financially, and arguably you may be doing yourself more harm even from a FICO perspective within the next decade by paying that student loan off early. I'm not seeing really any short-term upside other than pride/emotional benefit of getting it paid off. So you'll be there in 1.5 or 2 years instead of 1, it doesn't matter rationally.

+100000000000000000000000 this is great advice, agree 1000% percent

Re: A General 401k/Loan Repayment Finances Question

Crashem — Thu, 19 Apr 2012 07:32:34 GMT

Every 401k loan program works differently so yours may be different. But I know how fidelity works and they are one of the biggest. So going to use them as example. 1) 401k loans don't usually report to credit bureaus unless defaulted but usually enough in 401k to cover even default so nothing ever gets reported. So credit concerns are ilrelevant 2) usually there is a small fee for servicing loan or on initial setup. The interest you pay is essentially being paid to yourself and essentially becomes your rate of return. 3) you use after tax dollars to pay back loan which is double whammy. However you borrowed pre tax dollars and basically no other loan allows you to use pretax dollars to pay so essentially a wash in my opinion 4) if you leave the company for any reason (fired or changed jobs), there is usually an acceleration clause that will cause your payments to get much bigger. In some cases, it has to be paid back in 60 days or less. Failure to do so is really bad. Forget the credit concerns as I think in most cases there isn't any. Instead you will owe tax on it and a stiff penalty on top of it. So assuming most of what I am saying is true in your 401k. I would recommend you reduce your contribution to 4% and use the remaining to pay down the 401k loan faster. In some cases you can't even adjust the payments but only lump sum remaining balance. Why? Here is how I am looking at it. Your 401k money is only earning you 2.5% on after tax dollars. Your 401k is doing 5% (might want to check what options on funds you can invest in). Basically you want to stop earning half the interest rate as soon as possible. Also if there are acceleration clauses or quick payback in your 401k, that is an un intended expense when you can least afford it.

Re: A General 401k/Loan Repayment Finances Question

GrowingCredit — Thu, 19 Apr 2012 19:09:55 GMT

oracles wrote:
Revelate wrote:
No, paying off an installment loan isn't a huge factor except for DTI calculations on a mortgage or auto loan.

Keep contributing to that 401K, that annual rate of return is compounded, so money you put in now, counts for quite a bit more than money you put in 10 years from now. Never give up a long-term benefit for short-term satisfaction financially, and arguably you may be doing yourself more harm even from a FICO perspective within the next decade by paying that student loan off early. I'm not seeing really any short-term upside other than pride/emotional benefit of getting it paid off. So you'll be there in 1.5 or 2 years instead of 1, it doesn't matter rationally.

+100000000000000000000000 this is great advice, agree 1000% percent

+1. I have about $20000 in student loan and I pay monthly min what is required. At the end of the year I get the interest back so it is almost an interest free loan. I would rather have that extra money in my 401k or my savings toward my housing DP.

Re: A General 401k/Loan Repayment Finances Question

AndySoCal — Fri, 27 Apr 2012 01:44:30 GMT

Keep in mind with 401k Loans you are lender and the borrower. IE you are borrowing form your self.

Re: A General 401k/Loan Repayment Finances Question

js0319 — Fri, 27 Apr 2012 15:08:09 GMT

There are two ways to get money out of your 401k, depending on the types of 401k accounts you have. Those are generally traditional and Roth 401k's. In a traditional, you would have to pay taxes and penalties on whatever you borrowed, and typically you get about 60% after the taxes and penalties. In a Roth, you have a vested amount within that account, and you pay taxes on it before it goes into the account. Generally, with a Roth 401k loan you can borrow against your vested balance and pay back over a period of time, with the minimum typically being 1 year. You cannot pay it off early, but you do pay it back with interest. The interest, however, goes directly back into your Roth 401k. There is also usually a small fee associated with the loan.

I did a Roth 401k loan about a year ago, and just finished paying it off. I borrowed $1800 against my Roth 401k balance, and paid back a total of $1907 (4% interest and a $35 fee). I essentially had to pay myself $72 in interest. My weekly payment (deducted from my paycheck) was about $37.

Generally, you would only want to borrow against your 401k if it's a Roth 401k. You can't put back in what you've taken out in a traditional.