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I am considering using a TSP loan versus a credit union loan to finance the purchase of our next vehicle. I am trying to weigh the relative costs (both direct and indirect) between the two options.

The credit union is offering a 2.0% APR for 36 months and 2.4% APR for 60 months The TSP is offering 2.25% APR for 60 months

According to the TSP website:

Direct Costs

Loan Fee. The TSP charges a loan fee of $50 for administrative expenses. The TSP deducts the fee from your loan proceeds. For example, if you request a loan for $1,000, the amount paid to you will be $950.

Interest. The interest rate on your TSP loan is the G Fund rate at the time your loan application is processed. This rate is fixed for the life of the loan. Although TSP loan interest is not tax-deductible, all of the interest goes back into your TSP account.

Indirect Costs

Indirect costs include sacrificed earnings. When you take a TSP loan, you sacrifice the earnings that might have accrued on the borrowed money, had it remained in your TSP account.

Although you pay the loan amount back to your TSP account with interest, the amount of interest paid may be less than what you might have earned if the money had remained in your TSP account.

My investment philosophy across my entire portfolio, of which my TSP is only a portion, is to have a fixed asset allocation between stocks and bonds and I re-balance across the portfolio periodically to maintain the established allocation.

Therefore, my question is this, if the amount of the TSP loan is small enough such that I can effectively take it only from the G Fund (US Govt bonds) by doing an inter-fund transfer after the loan processes to reestablish the previous balances in the F, C, S, and I funds, is there really any indirect costs of sacrificed earnings since the loan's interest rate is based on the G Fund interest rate and the loan interest payments are credited back into my TSP as I repay the loan?

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I don't have experience with TSP in particular, but they look to be roughly the same as 401(k) loans. If the "G Fund rate" is equal to the yield of government bonds, then your main risk is the risk that yields increase, which means the interest you're paying is less than what you would have earned on the investments.

Here are some other things to consider:

  • the loan will be due in full if you leave your employer. You might not be able to refinance the loan if you decide you don't want to work for the government anymore, which might put you in a bind. Worse yet, if you are furloughed or laid off for any other reason, you might have to scramble to repay the loan
  • Do you rally want a car payment for 5 years? You'd likely be underwater for at least 2 years on a used car, and 3 or more on a new car (new cars lose 11% of their value the minute you drive off the lot, and another 10% in the first year of ownership.

For any car loan, I would borrow as little as possible with as short a term as possible. To me, the interest savings and additional risks from borrowing from your retirement isn't worth it.

  • Not sure where the 0.15% number came from. I would be saving 2.0% or 2.5% minus $50 since I "lose" the credit union interest payments. However, the TSP loan interest payments get credited back into my TSP account. You are correct, TSP is the federal gov't equivalent of a 401K. Also, there are provisions that protect against a gov't furlough. – Daddy the Runner Aug 15 '17 at 22:08
  • I was taking 2.4% minus 2.25%, but I see your point about paying yourself the interest. So that is a bit better and I removed that bullet. I still don't like car loans in general, let alone 5-year loans, so I still can't recommend it, but that wasn't your question :) – D Stanley Aug 15 '17 at 22:17
  • I agree, paying cash is the best option. However, most of my net assets are tied up in tax advantaged accounts (thanks to maximizing annual contributions). Therefore, borrowing against them and fully replenishing them for $50 seems like a very reasonable "best" alternative before taking out a traditional car loan. I also echo your statements about minimizing the duration of a car loan. Historically, I've always paid off car loans in less than three years and owned them for 10+ years. – Daddy the Runner Aug 16 '17 at 3:12
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Never borrow money to purchase a depreciating asset. Especially don't borrow money that has penalties attached.

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