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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75807  
Subject: Re: 401k Borrowing Date: 10/31/2007 12:16 PM
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If you're both earning and paying the interest, then your net gain is zero.

Now, that *may* be better than paying interest to another lender, where your net return on that loan is negative. Yes, that's true.

BUT, you're *still* losing 8-10% typically on investment returns.

So, the net effect is still:
401K loan: 0 - investment loss = -9% typically (pre-tax, remember)
other loan: varies greatly depending on a lot


Okay, let me run some numbers here:

You have a $10k balance in your 401(k). Today, you take out a $1000 loan at prime + 1 (currently would be 8.75%, at least until the Fed announces today), to be paid back over 1 year. For convenience sake, let's say you also earn 8.75% on your invested assets (close to your 9% and higher than the 8% I usually use for projections). Let's say there is also a $35 set up fee and a $3 quarterly fee for each quarter after the set up, so over the course of the year, you would pay a total of $44 ($35 plus 3 $3 quarterly fees).

For simplicity's sake, we won't consider any other contributions to your 401(k), even though most 401(k)s allow you to make contributions while you have a loan.

One year from today, with your loan paid off and the fees taken out, your total balance in your 401(k) will be $10,831

If you had just left your $10k balance in, and it had earned 8.75%, you would have $10,875 in your account.

Net difference: The $44 in fees.

However, assuming that you were borrowing elsewhere, at the same 8.75% rate, you would have paid $875 to another lender.

So, your net worth would be actually be $831 less if you borrowed elsewhere, vs. borrowing from your 401(k).

The biggest danger with a 401(k) loan is the possibility of defaulting on the loan and having to pay the taxes and penalty on the withdrawal. So having a contingency plan that provides for that is critical.

AJ
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