the danger of a 401k loan

[Scott W.]

I'm sure it's been discussed before but I'd like to tell something I see (correct if I'm wrong):

a 401k loan should be among the last resorts for borrowing. reason being is you pay it back AFTER taxes.  if you live in Illinois and are in the 25% federal bracket, that's 29%! and it's EVERY time you take a loan.

I did a home equity line of credit at 4% last year. I get to deduct it so the cost of the $ is around 3%?  A TON cheaper than the 401k loan.  a 401k loan is almost the equivalent of a hard $ loan.

oh, and you don't get to deduct the cost of paying those taxes back on your real estate investment.

IMO, a lot of people don't have a clue about their true cost of borrowing for this vehicle. it's not mentioned on the internet very much either.

there's a guy I know who is an underwriter for a bank and doesn't know about this; I feel bad for people who don't see the true cost of this.

search for private loans, bank loans before this. and make sure you know how much of a hit you will take. for a $50k 401k loan, that's almost $15k you eat!

if I'm wrong, please correct me!

[Cory Adams]

What? When you pay back your HELOC you are paying back principal and interest with after tax dollars. You may be able to write off the interest paid if the HELOC is taken out on your primary residence.

When I pay back my SD 401K loan there are 2 costs: 1) opportunity costs for earning income in the 401K tax deferred (if you think the loan will offer a better return then discount this option) 2) The interest you charge yourself cannot be written off vs the HELOC (for a HELOC secured against primary residence).

The cost difference is the interest that cannot be written off but if you have a SD 401K the interest is going back into your account and presumably somebody else is paying that interest because you used the 50K for a down payment on income property.    

I'll give you an example: for a 50K loan at 4.25% assuming tax bracket of 32%. The first year interest will be 1947.77 and writing off the interest in a similar HELOC would have allowed you to save 1947.77 *.32 = 623.29. The interest drops off as the loan progresses to year 5 which is a couple hundred bucks.

The cost of a SD 401 K loan through my provider (mysolo401k) was negligible.   If you would like to know more of those details reach out to Mark Nolan here on the site.

At the end of the day this is another source of down payment funds which given my situation I believe to be better than a HELOC. My personal reasons: 1) The loan does not show up on your credit report. 2) The interest is going back to my account. 3) It was much cheaper to do and easier than a HELOC to obtain. 4) I thought that this was the highest and best use of these funds as I had the money sitting in a money market fund anyway as I'm a bit timid of the stock and bond market at this time.