I have paid off all my debts except my mortgage and I have a 401K loan. I have a 15 year mortgage at 3% interest. I was thinking of increasing my 401K loan payments or increase my 401k contributions. I also considered increasing my mortgage payments by paying extra principal.

  • Are you already contributing enough to 401k to get full company match (if any)? Are you maxing out Roth IRA contribution each year too?
    – Hart CO
    Nov 10 '20 at 21:30

There are several potential things that need to be understood and balanced.

  1. Risk of job loss when you have a 401(k) loan. If you lose your job, or you change employers, the payoff period is accelerated. This can either drain your savings, or have tax impacts.

  2. From a pure interest amount the advice is to pay off the one with the higher interest rate. The mortgage is 3% and may be fully or partially tax deductible, but what is the interest rate of the 401(k) loan? If it is more than 3% that would be the one to payoff first.

  3. When you have a 401(k) loan some companies suspend the company match. In those cases paying off the 401(k) loan quicker gets you back that benefit quicker. Check the rules of the plan.

  4. Some 401(k) programs don't allow you to make contributions while you have a loan. All money you send to the plan goes to paying off the loan. Check the rules of the plan.

  5. Paying additional money into the mortgage does reduce the principal, but that benefit is deferred until either the mortgage is paid off early, or the property is sold, or the mortgage is refinanced. Paying extra doesn't reduce the required monthly payment, which would be a nice option if at some point you lost your job.

Without knowing the numbers:

I would get rid of the 401(k) loan,that would reduce your risk. It also gets your retirement account balance where it should be. After paying off the 401(K) loan then extra cash could be used to increase retirement savings in the 401(k) or a Roth IRA or traditional IRA, depending on your situation.

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