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I have a loan with a 9% annual interest rate compounded monthly with about $7050 left on it. My minimum monthly payment is $356, which is all I've been able to afford lately, with the occasional bump from tax returns etc. I also have a lower interest rate car loan and a mortgage.

I'm contributing $550 monthly to my 401k, which over the last 12 months has had a 12.98% rate of return. My employer doesn't do any matching.

Does it make sense to decrease my payment or entirely stop paying into my 401k temporarily to help pay off my 9% loan more quickly? Once it's paid off, I would resume full investment and potentially put some of that extra $356 a month into it for a little while to make up for the lost time. Alternatively, keeping that extra $356 a month is also tempting so that I can build up my savings account.

  • What are the principal and rate on the car loan? – RonJohn May 20 '17 at 14:24
  • What is the car worth? If you are not upside down, you should consider trading down. That would both free up the car loan payment to pay toward this one instead, and lessen the amount you have tied up in an asset that is quickly declining in value. – Wesley Marshall May 20 '17 at 15:29
  • Do you have a Roth IRA, or just the 401k? I ask because you can withdraw your contributions from a Roth IRA without tax (you already paid tax on it)/penalty. – Hart CO May 20 '17 at 16:14
  • I have a Roth IRA with a very small amount of money in it that wouldn't really contribute anything useful. The rate on the car is between 2 and 3 percent (don't remember right now) but I'd rather not switch cars again right now if I can avoid it. – Ed Marty May 20 '17 at 19:08
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My employer doesn't do any matching.

As soon as I read this statement, my thought was that, yes, you should stop investing for retirement that is years away and pay off these loans that are causing pain now. Your 12% return isn't guaranteed forever, and often will be less that the 9% you're paying in interest.

I would not stop at this loan, though. I would attack the car loan next, taking your retirement and other loan payment and putting another $900 a month on it. Hopefully that will get your loan paid off quickly, unless you have a ridiculously high car loan, in which case I would consider moving down in car until you are in a better financial position.

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    Random thoughts: would it be feasible to take a loan from 401(k) to close the loan in question and then repay yourself instead of paying the interest to the bank? – n0rd May 20 '17 at 15:58
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    I mostly agree, but car loans can have very low interest rates (1-2%) so might not be worth paying off the car ahead of establishing a proper emergency fund and getting other things in order. – Hart CO May 20 '17 at 16:22
  • Can the down-voter provide a reason? – Hart CO May 20 '17 at 16:32
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    @n0rd the problem with a 401(k) loan is you miss out on the gains while you are paying it back. Plus if you leave your job the entire loan is due in full. I would just pay it off as soon as you can and not exchange one loan for another. – D Stanley May 20 '17 at 17:20
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    Shame on you @n0rd. A 401K loan? The worst of all options. – Pete B. May 22 '17 at 11:58
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Three Options:

  1. Carry on with current 401k contribution and loan repayment ($550 to 401k, $396 to loan).
  2. Stop 401k contributions and focus on loan ($906 to loan).
  3. Take out a 401k loan to pay off the loan immediately, then repay 401k loan. ($906 to 401k loan).

401k Loans
A 401k loan has an interest rate (~5% today), but that loan interest gets paid back into your 401k account. The down-side of a 401k loan is that you miss out on potential gains by reducing your 401k balance. There's also a small amount of double-taxation on the interest you pay yourself, since it's paid with after-tax dollars, for example if you get a $7,050 401k loan at 5% and are in the 20% income tax bracket, paying back your full $906/month you'd pay ~$26 in extra tax over the course of your 401k loan, not a huge amount, but worth noting. Also, if you leave your current company before repayment is finished, you have a limited amount of time to finish repayment in full, or the outstanding balance of the loan gets treated as a distribution subject to the 10% early withdrawal penalty.

With a 401k loan you save on paying your loan interest from day 1, and you start rebuilding your 401k balance with your first payment. A 401k loan is most attractive when it's short term and it enables you to avoid paying a high interest rate.

Option Comparison
I looked at all 3 options above using a range of 401k return rates (0-20%).
Assuming that in each scenario the full amount goes to your 401k after loan repayment is done. The result is that a 401k loan beats the others unless your 401k returns at above 9%, at which point it is better to just keep on with current payments. The difference between the options is pretty insignificant if your 401k returns near 9%, even if it dipped to 0% you'd only save ~$240 by going with a 401k loan.

My Answer
I wouldn't count on a 401k sustaining > 9% growth, and because reduced debt gives you increased flexibility and may help you avoid future debt, paying off the loan early seems best. While a 401k loan could come out ahead of just putting $906 to your loan each month, it wouldn't save you that much money even in the worst case scenario, and would cost you a little bit if 401k returns stay high. I would be tempted to borrow from my 401k because I'm curious to find out how easy the process is, but if I thought there was a chance my employment situation would change in the near future, I'd avoid the 401k loan, temporarily stop contributing and pay the debt down quickly.

Here's a good article on 401k loans: Sometimes It Pays to Borrow from Your 401(k)

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