Results of the 401k Loan


So as I mentioned from the previous post A Good Reason to take a 401k Loan I took a 401k loan for 1 year to refinance my mortgage. I was able to lower the mortgage from 4.5% to 2.5% and the term from 30 to 15 years. This left the monthly mortgage payment at roughly the same amount as before but it will save about 150k in interest over the life of the loan. So from the mortgage side, yes this was worth it.
But the real question is, was the 401k loan worth it? That takes a bit more investigation since I could have sold off additional investments, just waited until I saved up enough or used a Peer-to-Peer Loan or Second Mortgage to cover the rest.
NOTE: I actually paid off the 401k loan in 6 months instead of a year so these analysis will only cover that period

Selling off investments

If I had decided to go with the selling of investments I would have incurred the short term capital gains taxes which would be 25%. So I would have to sell 133% of the lacking funds to cover taxes as well (133% * 75% = 100%). In addition I would have missed on those investments a 20% gain which means this move effectively costs 160% of the needed cash. This results in a “loan” APR of 156%.This would have been the most expensive option… well payday loans might have been more expensive.

Saving up the cash

This would have delayed the refinance by 6 months so looking at the historical rates the best rate around that time would have been 3%. Not too bad, just a 0.5% higher though that means that I would lock in about 21% more interest paid over the life of the loan. That seems like a lot but that amount in interest was only 60% of what I was borrowing from the 401k over 15 years which results in an “loan” APR 3.2%.

Home Equity/Peer-to-Peer Loan

We could have also gotten a 2nd mortgage at the rate of 5% to cover the lacking amount however that would have resulted in a loan with the APR of 5.05%

401k Loan

Minus the $45 in fees, all interest was paid into the account resulting in a 11.4% gain over the period versus the 11% gain for the market. I was also able contribute to the 401k while having the loan thus I didn’t lose the employer match. So due to taking out the loan before the market went down (which was pure luck) and repaying the loan as the markets climbed I effectively got to borrow the money for free. The effective “loan” APR is -6.9%.

So in this case everything worked out beautifully for the 401k loan. It not only was not a disaster, but actually the best choice I could have made. So to wrap it up, yes usually 401k loans are horrible, but there are real life examples of when it pays off nicely. Just remember to keep the term as short as possible and continue to contribute to the 401k during the loan.

What do you think? Was there another option that I overlooked? Do you disagree with my calculations? Leave a comment below.

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