Following up on the topic of 401(k) loans, which was discussed here, there is a new article on CNN Money by Walter Updegrave. This article compares a scenario for two options: borrowing $40,000 through a 401(k) loan and borrowing the same amount through a home equity line of credit. Assuming the two options are available to an individual in need, one comes out better when exercising the home equity line option.
Here’s their calculation:
| Borrow from 401(k) | Borrow from Home Equity Line |
| $40,000 4-year loan | $40,000 4-year loan |
| Monthly payment $934 | Monthly payment $926 |
| $100,000 Beginning 401(k) balance | $100,000 Beginning 401(k) balance |
| - 40,000 Loan | |
| $ 60,000 401(k) balance after loan | |
| 15,749 Earnings on 401(k) at 6% annual return | 26,248 Earnings on 401(k) at 6% annual return |
| 44,832 Loan repayment (48 X $934) | |
| 5,773 Earnings on monthly loan payments at 6% annual return | |
| $126,354 Ending 401(k) Balance | $126,248 Ending 401(k) Balance |
| 384 Savings from lower loan payments ($926 vs. $934) 1,112 Tax savings on home equity loan interest | |
| $126,354 Final 401(k) balance | $127,744 Final 401(k) balance plus other savings |
Source: CNN/Money
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12:15 pm (reply)
Makes sense, but the chart is assuming a couple things…
1. That the borrower has a home. I see from the article that this is the case.
2. That there are no closing costs or fees with the HELOC. In this case, the borrower already had one.
3. Interest rates stay relatively low. The interest rate on the HELOC was prime minus .25, while the 401(k) loan was fixed.
401(k) loans aren’t great, but they aren’t the evil “double-tax” loans that people like Suze Orman make them out to be.
erin
http://frugalgirl.blogspot.com/
2:28 pm (reply)
I agree with Erin. If Prime rate increase 1% 12 months from now, which is very possible, the comparison will be up side down.
3:42 pm (reply)
I won’t deny that in many cases borrowing from a 401(k) loan is a better option, and that assumptions can be played with in order to get any result you want. The best option is never to have to borrow money in the first place. Wouldn’t that be nice?
4:52 pm (reply)
I agree! Just another reason we all should save three-six months of living expenses.
erin