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More on 401(k) Borrowing

This article was written by in Investing. 8 comments.


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

Updated March 5, 2014 and originally published March 30, 2005. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 4 comments }

avatar erin

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/

avatar Personal Finance Blog

I agree with Erin. If Prime rate increase 1% 12 months from now, which is very possible, the comparison will be up side down.

avatar Luke Landes ♦127,480 (Platinum)

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?

avatar erin

I agree! Just another reason we all should save three-six months of living expenses.

erin

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