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401 K plan allows me to take a loan and repay it in monthly installments with 5% additional, which adjusts it for inflation, i.e., I do not have to pay any fees or interest rate for my loan.

I know have enough money to repay this loan, however I started to think instead of paying it back, I will invest it in a good ETF and pay the loan off by paying every month till end of the loan.

Assuming rate of return in the next 5 year is higher than MF that grows at slower rate, is it a wise strategy, or is it better to just pay it off?

any pros and cons on this? thanks

Thanks for all the responses. I am thinking of paying it off. My plan only takes the full amount outstanding and not partial payments or accelerated payments. Therefore, had to wait until I had money equivalent to the outstanding balance.

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    If you "have enough money to repay this loan", why isn't that money invested in a good ETF? – RonJohn Nov 3 '19 at 6:29
  • "Assuming rate of return in the next 5 year is higher than MF that grows at slower rate". This doesn't make sense. What Mutual Fund are you referring to which grows slower than the ETF? – RonJohn Nov 3 '19 at 6:30
  • And how do you guarantee that the ETF grows faster than the MF? (And how do you guarantee that it grows faster than the 5% loan + capital gain taxes?) – RonJohn Nov 3 '19 at 6:33
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Why wouldn't you pay it back now, and then invest it inside the 401(k) in that ETF - that way you get the profit tax deferred?

Basically, you're taking the same game as if you take on a loan and invest the money right away (which is generally considered a bad idea because of the risk), just with the additional negative of losing the tax-deferring.

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  • "That ETF" is probably not one of the investment options available in OP's 401(k), or it is only available in a wrapper that adds significantly to the expense ratio. – Ben Voigt Nov 4 '19 at 14:35
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It sounds like more risk than it's worth. Depending. We'd be guessing at the details, such as:

  • What is the company match, if any?
  • Do you still get the match while loans are outstanding?
  • How much per year do you currently deposit?
  • What are the fees (annual expenses) by fund?

First. Always deposit to get the company match. Free money. Let's say the returns are identical between the chosen 401(k) fund and the ETF you choose. You don't seem to gain much. Look at the 5% however you will. A fixed 5% in the acct, and a potentially higher/lower return outside with the same money. Ron's point that you are creating cap gains outside the 401(k) is true, but offset by potential lower taxes at retirement.

I am not a "never-loaner". There are many scenarios where a loan can make perfect sense.

  • When the loan bridges the gap between 80%LTV and the current LTV on a potential home purchase, by eliminating PMI.
  • When a high interest debt (say 18%+) can be paid off, with the warning that all the behaviours that led to it have been addressed.
  • When the choices within the 401(k) have such high fees (there are still those that run 2%), that borrowing out half the value and doing what you suggest is a great idea.
  • When a sibling/child needs a vital organ and would have no means to pay on their own. Assuming you like this person.

In the end, without the extra details, I don't see a clear case for this being very beneficial. Nor do I see it being 'bad'.

I'll share. Years ago, I had a mortgage which was relatively high interest, and also a jumbo loan. I used a 401(k) loan to pay it down, and then made higher payments for a year. Then, it was below the 'jumbo' threshold and general rates were lower. Using $50K to drop a $400K+ mortgage's rate by over 1.5% gave me math I was happy with. Just an example.

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