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I have a loan out on my employer 401k plan for $50k, which I took out for the purchase of a home (so there was no penalties, or taxes withheld). The interest rate is 4%, which I'm paying into the account, and the term of the loan is 15 years.

I can pay the loan back in full at anytime. My previous home just sold so now I have the money to pay the loan back (and still have plenty of liquid funds for emergency funds, and savings etc).

I am leaning towards just paying the loan back fully but was wondering if I should consider investing it into other investment vehicles such as an IRA (traditional or roth) or even index funds. I do not currently have an IRA, and before I took out the 401k loan, I had just started investing the maximum allowed per year in the 401k (but not putting any money in IRA's yet, because we were not comfortable with income less then what we took home after said contributions).

Would there be any benefit to this? Or should I just repay the 401k?

  • 401(k) loans for home purchase are limited to a 10 year payback term. – JoeTaxpayer Jan 20 '16 at 1:11
  • I just checked, I was wrong about 30 years, but my loan term is 15 years. Updated question – Anon Jan 20 '16 at 1:19
  • also I'm curious, where are you getting the 10 years being the "limit"? Besides what I'm seeing in my loan terms, I also did a quick google search and guideto401kloans.com states 10 to 15 years is common for a home purchase pay back term. – Anon Jan 20 '16 at 1:34
  • One factor to weigh in is that if you change jobs you will have a very short amount of time to pay it back. If your other investment is down at the time that might be a hardship. – JohnFx Jan 20 '16 at 2:01
  • My mistake. 5 year limit for non-home loans, but you are right, 10 was just my own experience, not the legal limit. Haven't found a definitive statement for maximum time. – JoeTaxpayer Jan 20 '16 at 12:22
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Pay the 401(k) loan back as soon as possible.

To be clear, the money from your 401(k) loan is no longer invested and working for you. It doesn't make sense to pull money out of your 401(k) investments and then invest it in something else. If you want to invest for retirement, pay back the loan and invest that money inside your 401(k).

If you leave your job, the 401(k) loan needs to be paid back in full, or else taxes and penalties will apply. If you have put the funds in an IRA, they won't be available to you should you need to pay back the loan early.

Instead of making a monthly payment to the 401(k) loan, pay off the loan and then make a monthly investment to an IRA.

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This summer I used a loan from my 401(k) to help pay for the down payment of a new house. We planned on selling a Condo a few months later, so we only needed the loan for a short period but wanted to keep monthly payments low since we would be paying two mortgages for a few months. I also felt like the market might take a dip in the future, so I liked the idea of trying to cash out high and buy back low (spoiler alert: this didn't happen).

So in July 2017 I withdrew $17,000 from my account (Technically $16,850.00 principal and $150 processing fee) at an effective 4.19% APR (4% rate and then the fee), with 240 scheduled payments of $86.00 (2 per month for 10 years). Over the lifetime of the loan the total finance charge was $3,790, but that money would be paid back into my account. I was happy with the terms, and it helped tide things over until the condo was sold a few months later. But then I decided to change jobs, and ended up having to pay back the loan ~20 weeks after it was issued (using the proceeds from the sale of the condo).

During this time the market had done well, so when I paid back the funds the net difference in shares that I now owned (including shares purchased with the interest payments) was $538.25 less than today's value of the original count of shares that were sold to fund the loan. Combined with the $150 fee, the overall "cost" of the 20 week loan was about 4.05%. That isn't the interest rate (interest was paid back to my account balance), but the value lost due to the principal having been withdrawn. On paper, my account would be worth that much more if I hadn't withdrawn the money.

Now if you extrapolate the current market return into 52 weeks, you can think of that loan having an APR "cost" of around 10.5% (Probably not valid for a multi year calculation, but seems accurate for a 12 month projection). Again, that is not interest paid back to the account, but instead the value lost due to the money not being in the account. Sure, the market could take a dip and I may be able to buy the shares back at a reduced cost, but that would require keeping sizable liquid assets around and trying to time the market. It also is not something you can really schedule very well, as the loan took 6 days to fund (not including another week of clarifying questions back/forth before that) and 10 day to repay (from the time I initiated the paperwork to when the check was cashed and shares repurchased).

So in my experience, the true cost of the loan greatly depends on how the market does, and if you have the ability to pay back the loan it probably is worth doing so. Especially since you may be forced to do so at any time if you change jobs or your employment is terminated.

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