Mortgage Loans

[firsttimemama]

I saw this on another thread and didn't know it existed. What is a 401K loan? How does it work? What are the pros and cons to doing one?

TIA!

[webhopper]

If your plan sponsor allows you to do this, It is a loan that is taken from your 401k, usually the maximum is half of your entire 401k balance. You pay it back at a set interest rate, mine is 5.5%, but i've had different rates.  When you make the payment on this loan, the entire payment goes back into your 401k, even the interest... so you are paying yourself interest instead of a big bank. 

The pros are: this loan doesn't report to your credit report. You can refinance it for a longer term sometimes.  The interest gets paid to you, and your money will grow at a fixed rate for the duration of the loan. You can choose the number of months you want to repay the loan, and you can usually choose whether you want the payment taken from your paycheck or if you want it automatically debited from your bank account.

The cons are: this money grows at a fixed rate, so if all your other investments are growing at 15%, your loan amount only grows at 5.5%    So you do lose the growth potential.  Also, you are paying this back with after-tax money...  Same as you would a bank. You're just obtaining financing from the bank of "YOU"

If you lose your job you have to pay it all back immediately, or you will be taxed on the entire loan amount that hasn't been paid as it will become income at that point.

You may also have to pay early withdrawel penalties if you don't pay back you loan. 

[webhopper]

I used a 401k loan for my down payment, and then when I got my bonus in march. I paid off the loan and took out another loan, which was used to pay off 2 vehicles. One of the vehicles was financed at 22%, my fiance had some credit issues in the past, so his rate was terrible!  I figured that I wouldn't gain 22% on my money, so it was better to gain 5.5% than to lose 22%

[cassembler]

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webhopper wrote:

If your plan sponsor allows you to do this, It is a loan that is taken from your 401k, usually the maximum is half of your entire 401k balance. You pay it back at a set interest rate, mine is 5.5%, but i've had different rates.  When you make the payment on this loan, the entire payment goes back into your 401k, even the interest... so you are paying yourself interest instead of a big bank. 

The pros are: this loan doesn't report to your credit report. You can refinance it for a longer term sometimes.  The interest gets paid to you, and your money will grow at a fixed rate for the duration of the loan. You can choose the number of months you want to repay the loan, and you can usually choose whether you want the payment taken from your paycheck or if you want it automatically debited from your bank account.

The cons are: this money grows at a fixed rate, so if all your other investments are growing at 15%, your loan amount only grows at 5.5%    So you do lose the growth potential.  Also, you are paying this back with after-tax money...  Same as you would a bank. You're just obtaining financing from the bank of "YOU"

If you lose your job you have to pay it all back immediately, or you will be taxed on the entire loan amount that hasn't been paid as it will become income at that point.

You may also have to pay early withdrawel penalties if you don't pay back you loan. 

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+1, A very nice analysis.

I think the big negative that's worth emphasizing is that you pay back a 401k loan with after tax money, meaning you effectively get taxed twice on that same dollar (as opposed to just once)... That doesn't mean, "never ever do it," but 401k loans are generally considered a "think about it real hard" type of loan.

But, for minimum down payment costs, they can make sense in order to secure financing at these pretty awesome rates!

[cassembler]

Firsttimemama, I didn't realize this must be your "next question in another thread."

In your scenario, a 401k is definitely a good option to consider. I recommend only taking out what you really need to, and probably wait until you talk to a loan officer about it. They'll know best (theoretically).

[firsttimemama]

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cassembler wrote:

Firsttimemama, I didn't realize this must be your "next question in another thread." Lol. Yes, this was my next question. Though I'm sure I'll have plenty more as this journey continues...

In your scenario, a 401k is definitely a good option to consider. I recommend only taking out what you really need to, and probably wait until you talk to a loan officer about it. They'll know best (theoretically). I will definitely wait until I get to that point which will also give me a realistic picture of what amount, if any, I'll need.  I like knowing what options are available to me in the event I need them!

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[firsttimemama]

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webhopper wrote:

If your plan sponsor allows you to do this, It is a loan that is taken from your 401k, usually the maximum is half of your entire 401k balance. You pay it back at a set interest rate, mine is 5.5%, but i've had different rates.  When you make the payment on this loan, the entire payment goes back into your 401k, even the interest... so you are paying yourself interest instead of a big bank. 

The pros are: this loan doesn't report to your credit report. You can refinance it for a longer term sometimes.  The interest gets paid to you, and your money will grow at a fixed rate for the duration of the loan. You can choose the number of months you want to repay the loan, and you can usually choose whether you want the payment taken from your paycheck or if you want it automatically debited from your bank account.

The cons are: this money grows at a fixed rate, so if all your other investments are growing at 15%, your loan amount only grows at 5.5%    So you do lose the growth potential.  Also, you are paying this back with after-tax money...  Same as you would a bank. You're just obtaining financing from the bank of "YOU"

If you lose your job you have to pay it all back immediately, or you will be taxed on the entire loan amount that hasn't been paid as it will become income at that point.

You may also have to pay early withdrawel penalties if you don't pay back you loan. 

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Thank you for taking the time to explain it all to me. I like to know what I'm getting into before I decide to do it (at least as much as I can).

[Watchmann]

Usually you are limited to 1/2 of the 401(k) value or $50,000, whichever is less, and the payback is usually no more than 5 years.  So just be aware you'll have a pretty hefty loan repayment on the amount borrowed PLUS the new mortgage loan payment, plus taxes/insurance.  It may work for you, but if you don't have the funds for a down payment without having to borrow them I'm not sure it would be a good idea.  It would be better to save the amount needed for the down payment.

[firsttimemama]

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cassembler wrote:

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webhopper wrote:

If your plan sponsor allows you to do this, It is a loan that is taken from your 401k, usually the maximum is half of your entire 401k balance. You pay it back at a set interest rate, mine is 5.5%, but i've had different rates.  When you make the payment on this loan, the entire payment goes back into your 401k, even the interest... so you are paying yourself interest instead of a big bank. 

The pros are: this loan doesn't report to your credit report. You can refinance it for a longer term sometimes.  The interest gets paid to you, and your money will grow at a fixed rate for the duration of the loan. You can choose the number of months you want to repay the loan, and you can usually choose whether you want the payment taken from your paycheck or if you want it automatically debited from your bank account.

The cons are: this money grows at a fixed rate, so if all your other investments are growing at 15%, your loan amount only grows at 5.5%    So you do lose the growth potential.  Also, you are paying this back with after-tax money...  Same as you would a bank. You're just obtaining financing from the bank of "YOU"

If you lose your job you have to pay it all back immediately, or you will be taxed on the entire loan amount that hasn't been paid as it will become income at that point.

You may also have to pay early withdrawel penalties if you don't pay back you loan. 

---

+1, A very nice analysis.

I think the big negative that's worth emphasizing is that you pay back a 401k loan with after tax money, meaning you effectively get taxed twice on that same dollar (as opposed to just once)... That doesn't mean, "never ever do it," but 401k loans are generally considered a "think about it real hard" type of loan.

But, for minimum down payment costs, they can make sense in order to secure financing at these pretty awesome rates! Thank you! I don't want to lose out on these rates which is part of the reason I'm pushing to get all of my ducks in a row!

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[firsttimemama]

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webhopper wrote:

I used a 401k loan for my down payment, and then when I got my bonus in march. I paid off the loan and took out another loan, which was used to pay off 2 vehicles. One of the vehicles was financed at 22%, my fiance had some credit issues in the past, so his rate was terrible!  I figured that I wouldn't gain 22% on my money, so it was better to gain 5.5% than to lose 22%

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Sounds like the interest rate will be one of the most important factors for me to consider. Would a personal loan at a lower interest rate make more sense?