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I posted something about this loan quite a ways back (http://boards.fool.com/the-downside-of-401k-loans-31620604.a...), but we're finally at a point where we need to act on it. Got some good advice then (thanks AJ) but did not end up having to do anything at that time.

Well, now DW has accepted a new job, and given 30 day notice at her current company. It's a great career move. But there's an outstanding 401k loan that we will need to repay so that it won't be treated as a disbursement (taxes and penalties, eek!). This loan was taken towards the purchase/remodel of our home a few years back. The current balance is around $44.5k. Total liquid funds available (Efund, savings, checking account float, current cash in investment accounts, etc.) is roughly $70k.

Options are:
-Bite the bullet and pay it off from available cash. Ouch! My emotional side says that's too large a percentage of our liquid savings to give up at once.

-Cash out refi on the mortgage. Currently owe ~$370k on a $500k home. However, at a max LTV of 80%, we could probably only receive $20-25k by doing a cash out. The rest we would have to pay from our cash reserves. APR would be similar to our current mortgage, but closing costs are significant. I think closing costs make this unattractive unless the rate was a significant improvement over our current mortgage (it isn't).

-HEL/HELOC. HEL is maybe 4.5-5%, HELOC lower but variable. Could borrow the full payoff amount on a 10 year repayment.

-Borrow from my 401k. I could simply kick the can down the road by borrowing from my 401k. Primary benefit is that I pay the interest back to myself. It's essentially like putting a percentage of my 401k balance into a fixed bond returning 4%. Primary downside is loss of potential market gains (but also protection from market losses). This would be a 5 year repayment. Essentially this is the option to maintain the status quo. Also has the option of being extremely quick and easy to do.

-Split 401k loan and cash. I tend to prefer this one because the monthly cost going forward is smaller, and it's a smaller hit to our savings. Thinking roughly a 50/50 split.

-HELOC + cash. Figure out what I'm comfortable paying from savings, and open a HELOC for the rest.

Any thoughts or advice? We have room in our budget to cashflow any of the above options. Just trying to figure out what makes the best financial sense.
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Are you certain that you must pay back the 401K loan immediately? Some but not all plans allow continuing to pay the loan back under the existing terms.

Taking a loan against your 401K or taking out a HELOC doesn't require an immediate decision. Acknowledging that there is some emotional pain, you can pay off the loan and then give yourself time to decide whether a loan against your 401K or a HELOC would be a good idea.
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I'm not too familiar with 401k loans. What is the interest rate? Is this an installment loan and if so what are the terms? 5 year. 10 year. A 401k loan from your account would be similar or different?

Do you have plans for tbat 70k? It it's just sitting around for emergencies I would just use it. If it has another job like retirement or college education then leave it and let it do its job.

Not knowing the terms I would just do the HELOc, but will you have the same prob with LTV like you would with the cash out refi?
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-Bite the bullet and pay it off from available cash. Ouch! My emotional side says that's too large a percentage of our liquid savings to give up at once.

Wait - you said earlier "current cash in investment accounts is $70k" To me, that implies that you have other investments, along with cash, in taxable accounts. If that's the case, then you really need to look at it as a percentage of your current 'liquid assets' - including stocks, bonds, etc. - not just the cash.

-Cash out refi on the mortgage. Currently owe ~$370k on a $500k home. However, at a max LTV of 80%, we could probably only receive $20-25k by doing a cash out. The rest we would have to pay from our cash reserves. APR would be similar to our current mortgage, but closing costs are significant. I think closing costs make this unattractive unless the rate was a significant improvement over our current mortgage (it isn't).

That sounds like a very expensive way to access your equity, plus, cash-out mortgages usually have a higher rate, so you need to be sure that's priced in. I would cross this option off.

-HEL/HELOC. HEL is maybe 4.5-5%, HELOC lower but variable. Could borrow the full payoff amount on a 10 year repayment.

Wait - you have a 10 year loan that you've been paying on for 2 years, so you only have 8 years left on it. Why would you want to lengthen the term of the loan? If anything, especially since the interest you would be paying on the new loan will not be to yourself, you should be looking to SHORTEN the length of the loan - probably to 5 or 7 years.

-Borrow from my 401k. I could simply kick the can down the road by borrowing from my 401k. Primary benefit is that I pay the interest back to myself. It's essentially like putting a percentage of my 401k balance into a fixed bond returning 4%. Primary downside is loss of potential market gains (but also protection from market losses). This would be a 5 year repayment. Essentially this is the option to maintain the status quo. Also has the option of being extremely quick and easy to do.

And what's your plan to pay this 401(k) loan back, if something happens? As I've said several times before - NEVER take a 401(k) loan out without having a plan to pay it back if you change jobs.

-Split 401k loan and cash. I tend to prefer this one because the monthly cost going forward is smaller, and it's a smaller hit to our savings. Thinking roughly a 50/50 split.

Again - plan to pay this 401(k) loan back?

-HELOC + cash. Figure out what I'm comfortable paying from savings, and open a HELOC for the rest.

I would strongly suggest a slight variation on this - pay the 401(k) loan back with cash from your savings, and put the HELOC in place for a back up until you can build your cash reserves back to where you are comfortable. Then save like crazy to build the cash reserves.

Since this is a good career move for DW, hopefully it is coming with a pay increase. If so, how long will it take if you add the net increase, plus the payments that she had been making out of her paycheck, to build your savings back up? If the current payment is about $500/month, that's not quite 7.5 years if you just used the payment amount. But if you can add $500/month from DW's raise, that would cut the time to 45 months; if you can add $1000/month, it's down to 30 months, etc.

AJ
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I'm not too familiar with 401k loans. What is the interest rate? Is this an installment loan and if so what are the terms? 5 year. 10 year. A 401k loan from your account would be similar or different?

The terms of 401(k) loans are set by the plan, within limits allowed by the IRS. In this case, since the 401(k) loan was used as part of a home purchase, the IRS allows the term to be as long as 10 years. 401(k) loans for any other purpose (including a new 401(k) loan that the OP might take out) would only be allowed to have a maximum term of 5 years. 401(k) plans are allowed to set interest rates - many offer loans at prime or prime + 1.

Do you have plans for tbat 70k? It it's just sitting around for emergencies I would just use it. If it has another job like retirement or college education then leave it and let it do its job.

Since it's just cash, any 'job' that it may be doing isn't earning anything. If there is time and discipline enough to rebuild the cash before whatever 'job' it was slated for, the fact that it had a 'job' still wouldn't be a reason to not use the cash to pay back the 401(k) loan, IMO.

Not knowing the terms I would just do the HELOc, but will you have the same prob with LTV like you would with the cash out refi?

HELOCs generally don't have to conform to the same LTV requirements as conventional mortgages, because they are not sold to Fannie Mae or Freddie Mac, but rather, are often portfolio loans for the lender, or are sold to investors other than Fannie Mae or Freddie Mac. In fact, some lenders allow 100% LTV for HELOC, but generally charge a higher rate for a higher LTV. Here's one: https://www.coastal24.com/homeequity/home-equity-line-of-cre... In this case, they are offering rates as low as:

3.49% for up to 70% combined LTV
3.99% for up to 80% combined LTV
4.24% for up to 90% combined LTV
6.99% for up to 100% combined LTV

AJ
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How much have you had to dip into the Efund over the past 5+ years, and do you have a sizeable Roth IRA?

I've got a comfortable Efund and haven't had to dip into it much in the past 5-10 years. And I have a ROTH with at least 10 years of fully funding, so that's another $50K I could tap if I ever had to. So if it were me, I would just pay the loan back via the Efund and then start rebuilding the Efund.
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Always love getting your advice, AJ. You should really start charging for this service. ;)

Wait - you said earlier "current cash in investment accounts is $70k" To me, that implies that you have other investments, along with cash, in taxable accounts. If that's the case, then you really need to look at it as a percentage of your current 'liquid assets' - including stocks, bonds, etc. - not just the cash.

Actually, I'm all cash in the taxable account at the moment. That's $55 of the $70k. Then about $10k that we hold in the primary savings account, plus checking account float which can be $5-15k depending on the day of the month. More than 90% of our investment assets are in retirement accounts.

I would cross this option off. (Refi)
Agreed. Gone...


Since this is a good career move for DW, hopefully it is coming with a pay increase. If so, how long will it take if you add the net increase, plus the payments that she had been making out of her paycheck, to build your savings back up? If the current payment is about $500/month, that's not quite 7.5 years if you just used the payment amount. But if you can add $500/month from DW's raise, that would cut the time to 45 months; if you can add $1000/month, it's down to 30 months, etc.

Yes, it is a move with a pay increase. Salary and benefits together are probably $10-12k better than where she is right now. We're already in a position where we are cash positive - $36k to the 401k accounts each year, plus another $20-25k on top of that.

This is one of the reasons why I like the ease of the 50/50 cash/401k option. The 401k loan has a flat $50 fee, and no impact on my credit report. I plunk down some of the cash we already have on hand, and in about a year I would probably be in a position to pay the remainder without taking our cash reserves too low. Or I have the option to let it ride if I come up with a better use for that money. A $20k loan would be under $200/paycheck, easy to carry, with the interest paid to myself. If I were to leave my job, paying off a 401k loan <$20k shouldn't be too much of a hardship.
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This is one of the reasons why I like the ease of the 50/50 cash/401k option. The 401k loan has a flat $50 fee, and no impact on my credit report. I plunk down some of the cash we already have on hand, and in about a year I would probably be in a position to pay the remainder without taking our cash reserves too low. Or I have the option to let it ride if I come up with a better use for that money. A $20k loan would be under $200/paycheck, easy to carry, with the interest paid to myself. If I were to leave my job, paying off a 401k loan <$20k shouldn't be too much of a hardship.

So basically, you are using your 401(k) loan as a margin loan to fund your cash reserve account? And if something really bad happened the day after you paid off DW's 401(k) loan with your combo of cash and your 401(k) loan - like your entire group at work got laid off (yes, I know - you're pretty confident it won't, but just suppose.....), you'd be fine with paying your 401(k) loan off with the rest of your cash?

Guess I'm not sure why you haven't used a 401(k) loan to help bolster your cash reserves in the past, then.

AJ
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<<Well, now DW has accepted a new job, and given 30 day notice at her current company. It's a great career move. But there's an outstanding 401k loan that we will need to repay so that it won't be treated as a disbursement (taxes and penalties, eek!). This loan was taken towards the purchase/remodel of our home a few years back. The current balance is around $44.5k. Total liquid funds available (Efund, savings, checking account float, current cash in investment accounts, etc.) is roughly $70k.>>


This happens to huge numbers of people when they move on.


Personally, I consider these loans vexatious, since they tend to bump up people's taxes AND deflate their retirement assets at one blow.


Seattle Pioneer
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SeattlePioneer: "Personally, I consider these loans vexatious, since they tend to bump up people's taxes AND deflate their retirement assets at one blow."

I do not follow.

How does a 401-k loan bump up taxes?

How does it deflate retirement assets?

Regards, JAFO
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How does a 401-k loan bump up taxes?

How does it deflate retirement assets?


My guess is that SP is talking about situations where someone doesn't have the money to pay back the 401k loan.

PSU
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PSUEngineer:

<<<How does a 401-k loan bump up taxes?

How does it deflate retirement assets?>>

"My guess is that SP is talking about situations where someone doesn't have the money to pay back the 401k loan."

Then it does not appear to be inherent in a "401k loan" but in the fact the departure, may (but not necessarily) lead to a call.

Plans are not required by law to call loans on departure. The call provision is a feature (or bug, depending upon your perspective) of a particular plan or plans.

Regards, JAFO

(somewhere on these board is a discussion about my first home purchase using 10% down and 80% 1st mortgage and 10% "401k loan" to avoid PMI and higher interest rate of second lien loans, which was not callable upon my departure)
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So basically, you are using your 401(k) loan as a margin loan to fund your cash reserve account? And if something really bad happened the day after you paid off DW's 401(k) loan with your combo of cash and your 401(k) loan - like your entire group at work got laid off (yes, I know - you're pretty confident it won't, but just suppose.....), you'd be fine with paying your 401(k) loan off with the rest of your cash?

Guess I'm not sure why you haven't used a 401(k) loan to help bolster your cash reserves in the past, then.


Yes, I'd pay it off in that scenario as well.

But you're right, it seems like I am treating it as a margin loan from my 401(k) to put money into a more accessible account. That wasn't the case at the time we took the original loan out, but that's exactly what it's morphed into as our cash position recovered.

If the money is just going to sit in a cash account collecting a pittance in interest, it doesn't make a whole lot of financial sense, does it?
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<< SeattlePioneer: "Personally, I consider these loans vexatious, since they tend to bump up people's taxes AND deflate their retirement assets at one blow."

I do not follow.

How does a 401-k loan bump up taxes?

How does it deflate retirement assets?

Regards, JAFO>>


If you have a loan and quit or get fired, that loan becomes income if you don't repay it promptly.


And since if you quit or get fired and don;t repay the loan, the 401K is liquidated and you no longer have it as a retirement asset, just as a current tax bill.

This is a common trap people get themselves into, just as described in this thread.



Seattle Pioneer
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<< How does a 401-k loan bump up taxes?

How does it deflate retirement assets?

My guess is that SP is talking about situations where someone doesn't have the money to pay back the 401k loan.

PSU>>


Yes.

I'm guessing that a lot of people don't have Big Bucks to pay back that loan when they get fired.


Seattle Pioneer
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SeattlePioneer:

{{{SeattlePioneer: "Personally, I consider these loans vexatious, since they tend to bump up people's taxes AND deflate their retirement assets at one blow."}}}

<<<I do not follow.

How does a 401-k loan bump up taxes?

How does it deflate retirement assets?

Regards, JAFO>>>

"If you have a loan and quit or get fired, that loan becomes income if you don't repay it promptly.

And since if you quit or get fired and don't repay the loan, the 401K is liquidated and you no longer have it as a retirement asset, just as a current tax bill.

This is a common trap people get themselves into, just as described in this thread."


Thanks. As PSU suggested. I understand those issues.

As I noted in response to him, not all 401-k loans are due or become callable upon departure. This the problem is no inherent in all 401-k loans, but only in some (perhaps most) of them.

Regards, JAFO
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Which is why I suggested paying the loan off with cash instead of another loan, but setting up a HELOC as a 'just in case' fund.

AJ
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But you're right, it seems like I am treating it as a margin loan from my 401(k) to put money into a more accessible account. That wasn't the case at the time we took the original loan out, but that's exactly what it's morphed into as our cash position recovered.

Given what it has morphed into, you can just payoff the 401K loan. It will only hurt for a little while. In addition to the cash flow that has been building your cash reserves, the 401K monthly loan payment and her new additional income will be available to rebuild your cash position.
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Yes.

I'm guessing that a lot of people don't have Big Bucks to pay back that loan when they get fired.


Seattle Pioneer


Not all 401K loans are immediately due with separating from an employer.
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"SeattlePioneer: "Personally, I consider these loans vexatious, since they tend to bump up people's taxes AND deflate their retirement assets at one blow."" - JAFO31 | Date: 10/20/2016 4:14:54 PM | Number: 311048

I do not follow.

How does a 401-k loan bump up taxes?

How does it deflate retirement assets?

Regards, JAFO


From time-to-time the SeattlePioneer becomes confused. -- Not often; only occasionally.

WHOVPLLC
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<<"SeattlePioneer: "Personally, I consider these loans vexatious, since they tend to bump up people's taxes AND deflate their retirement assets at one blow."" - JAFO31 | Date: 10/20/2016 4:14:54 PM | Number: 311048

I do not follow.

How does a 401-k loan bump up taxes?

How does it deflate retirement assets?

Regards, JAFO

From time-to-time the SeattlePioneer becomes confused. -- Not often; only occasionally.

WHOVPLLC >>


Often enough, people take out loans on 401Ks, lose their jobs, can't repay them and wind up having the loan converted into income they must pay taxes on.

Not always ----but often enough.

I consider such loans a form of risky behavior myself.


Seattle Pioneer
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People at my work want them all the time for dental loans, cars, etc. they just pay a $50 fee for getting a loan and a $3 monthly fee on top of the interest they pay to the loan. There is no pay extra feature on the loans. You must pay all payments thru your paycheck. If you quit the loan comes due.
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You must pay all payments thru your paycheck. If you quit the loan comes due.

When the loan comes due after separating from the employer is dependent on the plan terms. Not all require immediate payment of the balance. Separation is for any reason and not just because the employee chooses to leave.
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SeattlePioneer:


<<"SeattlePioneer: "Personally, I consider these loans vexatious, since they tend to bump up people's taxes AND deflate their retirement assets at one blow."" - JAFO31 | Date: 10/20/2016 4:14:54 PM | Number: 311048

[[[I do not follow.

How does a 401-k loan bump up taxes?

How does it deflate retirement assets?

Regards, JAFO]]]

"Often enough, people take out loans on 401Ks, lose their jobs, can't repay them and wind up having the loan converted into income they must pay taxes on.

Not always ----but often enough."


So it is not the loan that causes the problem, but the failure to repay the loan.

Also, as previously noted, not every 401-k loan is callable when one leaves/loses his/her current position.

"I consider such loans a form of risky behavior myself."

More so than any other kind of loan? Any unpaid loan will likely also result in consequences if not repaid, including potentially loss of assets pledged as security to forgiveness of debt income (and perhaps broken bones if borrowing from the wrong lender (;>)).

What makes a 401-k loan worse?

Regards, JAFO
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What makes a 401-k loan worse?

Regards, JAFO


Two risks:
1. Early withdrawal penalties associated with conversion to a distribution
2. For plans that require immediate payment on separation from employer there is a lack of control over when the loan could be called

Mortgages and consumer loans also have risks but these are risks specifically associated with 401K loans.
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vkg:

<<<What makes a 401-k loan worse?

Regards, JAFO>>>

"Two risks:
1. Early withdrawal penalties associated with conversion to a distribution"<?I>

Which only occurs if the loan is not paid. Not certain that it is necessarily worse than having property foreclosed upon/repossessed.

"2. For plans that require immediate payment on separation from employer there is a lack of control over when the loan could be called"

Which, as we both know, is not all plans, so that risk is inherent in only certain 401-k loans, not all 401-k loan.

"Mortgages and consumer loans also have risks but these are risks specifically associated with 401K loans."

I agree that the risks you named, and as the second is qualified, are specifically associated with 401k loan, but that still does not answer why those risks are necessarily worse than the risks associated with mortgage and/or consumer loans.

Regards, JAFO
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<<"I consider such loans a form of risky behavior myself."

More so than any other kind of loan? Any unpaid loan will likely also result in consequences if not repaid, including potentially loss of assets pledged as security to forgiveness of debt income (and perhaps broken bones if borrowing from the wrong lender (;>)).

What makes a 401-k loan worse?

Regards, JAFO>>


A loan that becomes due and payable when you lose your job, and is deducted from cash you would otherwise receive when you are laid off, seems particularly vexatious to me.

That it may raise your taxes into the bargain is just another reason to avoid such a loan.


Seattle Pioneer
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<<Two risks:
1. Early withdrawal penalties associated with conversion to a distribution
2. For plans that require immediate payment on separation from employer there is a lack of control over when the loan could be called

Mortgages and consumer loans also have risks but these are risks specifically associated with 401K loans.>>


Yes.

In addition, of course, the investment gains one might otherwise hope for will be lost of money borrowed by this method.

And judging from the lack of knowledge of all these points by the relatively sophisticated people posting on this thread, I expect that MANY employees who take out such loans have even less understanding of possible negative consequences.



Seattle Pioneer
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<<"Two risks:
1. Early withdrawal penalties associated with conversion to a distribution"<?I>

Which only occurs if the loan is not paid. Not certain that it is necessarily worse than having property foreclosed upon/repossessed.

"2. For plans that require immediate payment on separation from employer there is a lack of control over when the loan could be called"

Which, as we both know, is not all plans, so that risk is inherent in only certain 401-k loans, not all 401-k loan.

"Mortgages and consumer loans also have risks but these are risks specifically associated with 401K loans."

I agree that the risks you named, and as the second is qualified, are specifically associated with 401k loan, but that still does not answer why those risks are necessarily worse than the risks associated with mortgage and/or consumer loans.>>


Mortgage and consumer loans DON't have the penalties and disadvantages described above.

I'm amazed that Jafo wasn't able to put 2+2 together here....


Seattle Pioneer
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<<"Two risks:
1. Early withdrawal penalties associated with conversion to a distribution"<?I>

Which only occurs if the loan is not paid. Not certain that it is necessarily worse than having property foreclosed upon/repossessed.

"2. For plans that require immediate payment on separation from employer there is a lack of control over when the loan could be called"

Which, as we both know, is not all plans, so that risk is inherent in only certain 401-k loans, not all 401-k loan.

"Mortgages and consumer loans also have risks but these are risks specifically associated with 401K loans."

I agree that the risks you named, and as the second is qualified, are specifically associated with 401k loan, but that still does not answer why those risks are necessarily worse than the risks associated with mortgage and/or consumer loans.>>


Mortgage and consumer loans DON't have the penalties and disadvantages described above.

I'm amazed that Jafo wasn't able to put 2+2 together here....


I don't see anything in your answer that refutes what JAFO said, or answered the question of why the 401(k) loans risks are worse than the risks associated with mortgages and consumer loans. You seem to be completely ignoring those risks.
- Both have penalties for late payments
- Both can be variable rate loans, which is great when rates are dropping, but can get ugly when rates are increasing
- Consumer loans can have penalty rates
- Mortgages run the risk of foreclosure and losing your home
- Mortgages and consumer loans both have provisions where they can be called at the lender's discretion if terms are violated
- If more than $600 of the debt is written off/forgiven for either mortgages or consumer loans, taxes will be due on the phantom income, compared to the 401(k), since you actually got money at some point, whereas with mortgages and consumer loans, you likely got an illiquid asset that couldn't net the balance of the loan, or the asset would be sold rather than being defaulted on.

The risks for 401(k) loans are not necessarily better or worse than those for mortgages or consumer loans - it depends on each individual's circumstances and risk tolerances.

AJ
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- Both have penalties for late payments

Penalties on consumer loans can be discharged in bankruptcy. It is difficult (not impossible) to discharge tax debt in bankruptcy.

The early withdrawal penalties are significant compared to most late payment penalties. Most late payment penalties are based on the payment and not the entire amount of the outstanding debt.

Credit cards used to be able to instantly raise rates after a missed payment. I am under the impress that regulations have restricted increases in interest rates.
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Penalties on consumer loans can be discharged in bankruptcy.

If one can qualify to file bankruptcy. Those who have filed for BK within the last 7 years, or who make too much to qualify for a Chap 7 BK, so will need to enter a Chap 13 BK repayment plan don't get the debt forgiven.

It is difficult (not impossible) to discharge tax debt in bankruptcy.

Including the tax debt that one owes for forgiven debts.

The early withdrawal penalties are significant compared to most late payment penalties.

And penalty interest rates are higher than the tax penalties.

Most late payment penalties are based on the payment and not the entire amount of the outstanding debt.

Actually credit card late fees are generally a flat amount, no matter how much the late payment is. There are also additional fees (over the limit fees, NSF fees, etc.) that are unlikely to be charged on a 401(k) loan. And penalty rates are charged on the entire balance, generally once 2 or more payments are missed.

Credit cards used to be able to instantly raise rates after a missed payment. I am under the impress that regulations have restricted increases in interest rates.

Yes, by law, you now have to miss 2 payments before the rates can be increased. But the minute the 2nd payment is missed, up go the rates in almost all cases. And the rates are charged on the entire balance.

Again, I'm not saying that there aren't risks with a 401(k) loan, just like the risks with any other loan. But each individual needs to assess their own risks based on their circumstances. And I still stick to my previous advice, that one MUST have a solid repayment plan for leaving one's job, either voluntarily or involuntarily, before taking out the loan.

AJ
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Again, I'm not saying that there aren't risks with a 401(k) loan, just like the risks with any other loan. But each individual needs to assess their own risks based on their circumstances. And I still stick to my previous advice, that one MUST have a solid repayment plan for leaving one's job, either voluntarily or involuntarily, before taking out the loan.

AJ


Yes, the critical point with a 401K loan is a plan for involuntary separation from employment.
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Yes, the critical point with a 401K loan is a plan for involuntary separation from employment.

It's not just involuntary separation that needs to be considered and planned for. This thread started as a question by someone whose DW had taken out a 401(k) loan, and has given notice for a voluntary separation from her current job, because a better job came along before the loan was paid off.

AJ
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It's not just involuntary separation that needs to be considered and planned for. This thread started as a question by someone whose DW had taken out a 401(k) loan, and has given notice for a voluntary separation from her current job, because a better job came along before the loan was paid off.

AJ


Involuntary separation doesn't allow any time for planning. Voluntary separation is under control of the employee. If a plan exists for involuntary separation that plan should work for voluntary separation. There might be a better option but at least a plan exists.
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