If you’ve been reading PDITF for longer than, say five minutes, you’ll know I’m not necessarily the smartest PF blogger of the bunch. But what I lack in brains I make up for in crappy stick figure drawings…right?
Over the years I’ve read a handful of articles about 401k loans. Most articles pretty much say the same thing, “They’re really dumb, so don’t do it.”
So for that reason, I’ve decided to consider taking out a 401k loan.
How you like them apples counterintuitive personal finance?!
Okay, I’m not necessarily considering taking out a 401k loan, as much as I am trying to figure out the reasons why I should not take one out.
I’m planning to take a 401k loan: Here’s some context
A few things to note….
- Girl Ninja and I have just shy of $100,000 in our savings account.
- When we finally find a house worth buying, it will probably be priced between $350k and $400k.
- We will put 20% down (so looking at about $70k to $80k).
- My govt job is stable (instead of facing furloughs I am working mandatory overtime)
So now that you know those basic things about me, allow me to try and explain why I’m flirting with the idea of using a 401k loan as part of my down payment.
I logged on to the TSP website (the government version of a 401k) and played around with their loan calculator. I ran some numbers based off a $30,000 TSP loan (to be used for part of our 20% down payment) being paid back over 3 years.
According to the calculator I’d be charged 1.75% interest on the loan, and would have bi-weekly payments of $395 taken out of my paycheck to pay it back. Over the course of the three-year payback period, I’d have paid a total of $810 in interest, or $22/month. There would also be a $50 administration fee charged upfront.
The cool thing (is cool the right word?) about a 401k loan is that, although I would have to pay $22/month in interest on the loan, that interest gets paid to my 401k balance. So I’m just paying myself interest, not the bank, not the government, just myself. Essentially I borrow $30,000 from myself and pay myself back $30,810 over the course of three years.
I’m failing to understand why is this a terrible decision?
The reality is the stock market has gone gang busters the last couple years.
What’s more, I didn’t start investing until 2007/2008. This means I missed the 2002 to 2007 bubble. Virtually all of my 401k investments were made while the market was “on sale”. This makes for some pretty incredible returns, not because I’m awesome at investing, but I didn’t have money to invest until the Dow was trading sub 10,000. Dumb luck I guess.
While it’s true the market could continue to go higher and higher for the next couple years, I don’t think it’s necessarily a bad choice to lock in a 25% YOY appreciation. Especially when I’m cashing out at HISTORIC HIGHS in the stock market to take advantage of mortgage interest rates that are still near HISTORIC LOWS.
So what am I missing here?
There are only two things I can think of that make this 401k loan option potentially stupid…
- The markets continue to go gangbusters for the next three years. I will be paying myself 1.75% interest on the loan which is a heck of a lot better than my savings account currently pays, but if the stock market goes up 20% a year for the next three years that will be painful to watch. My gut says this scenario is unlikely and the bull market will cool (especially as the fed lightens up on Quantitative Easing), but it is still a possibility and something to consider.
- If I get fired or quit my job I have to pay the loan back in full within 60 days. This is definitely the most popular reason PF bloggers advocate AGAINST 401k loans. But isn’t this because most people who take out 401k loans don’t have the cash on hand? I’ll have more than the loan amount in my savings account, so in the unlikely event I got canned, I could pay the loan in full no issue. Remember, I’m a firm believer “liquidity is king” so why not keep the cash in hand?
Okay, so like I said. I’m not the smartest kid in the room. Have I done all my homework?
What am I overlooking?
Note: If you think this decision is really stupid (which it totally might be) I just ask that use realistic numbers and analysis in your rebuttal as I’ve tried to do in this post. Not just a comment like “401k loans are for idiots.”