I’ve decided on buying a new truck (Ford F150 05’ model). My friend says instead of getting financing through the bank like I normally do, that I should get a 401K loan instead.
I didn’t like this idea because the intrest rate would be higher than if I went through the bank.
He claims that’s ok because any intrest paid is just being paid to myself.
While I agree with this I think it’s some what of a misnomer. Yes I’m paying myself back intrest true. But all I’m REALLY doing is making up for intrest lost after taking money out of my 401k.
Right or wrong?
The part where we both got lost is we didn’t know if say; I have 10K in my 401 then I take out a loan for 1k. Does the 401 still draw intrest as if I still had 10k in it? or would it only draw intrest for the 9k.?
You are right, your friend is wrong. It’s true that you pay back the interest to your own account, but this is of no benefit to you versus a bank loan, precisely because, while you have the money out, what’s left in the account isn’t earning the same amount of interest. In the example in your last question, your account only earns interest on the 9k, not 10k.
OTOH, it may be worthwhile depending on how your 401 is doing. If the interest rate you are paying in is higher than what the funds are making on the market, you can come out ahead. I took out a 401(k) loan right before the dot.com bubble burst and for a couple of years most of my interest income was the interest I was paying. But this doesn’t work out very often thank goodness.
Yes, you do repay yourself with interest. You also have to repay the entire loan within 30 days if you terminate employment. If you don’t or can’t, you then pay taxes and penalties since it is then considered an early distribution. Obviously if you have to take an early distribution, you have just wiped out whatever “savings” you could possibly have made by not taking out a regular bank loan. You also cannot take out more than 50% of your balance and you can’t get another loan until the first is repaid. If you have a real true emergency for which you need money and have absolutely no other way to get it, you’re SOL.
The reason taking a loan from your 401K is usually not a good idea is because even though you are repaying yourself, you are no longer making interest on the amount you took out. Lots of people also lower their contribution rate during the repayment period, thereby further lessening their future earnings.
As you said, the interest rate on 401K loans is not all that great. You can get a decent car loan for less than what you’d pay on a 401K loan.
