401K: Wait and Buy Low vs. Pay off Debt.

[Tico_75]

Hi everybody,

This is my first post here. Iin the past i used forums for so many things. this may be one of the most important decisions I will make in a long time so I am looking for help and advice.

401K: Wait and Buy Low vs. Pay off Debt.

I had been considering this for a while and I already gave it a lot of thought. The market is extremely bad and my 401k is at -22% right now. I know people say that this is the best time to buy low and we should wait loose money in the short term but let our investment grow on the long term. However, I am currently paying a prime rate for my loans and I can't wait to have the peace of mind of being debt free.

I am considering borrowing from my 401K. Before you raise your eyebrows and starts telling me to not do that consider the following. The reason I want to do it is to eliminate my debt in 2 years. This means, the money will be out of my 401k for around two years or less.

This is the plan.

I currently make the following monthly payments, I could probably pay more but this allows me to have a comfortable lifestyle. The numbers are rounded up.

#1. US Bank $100 ( $3,000 at 21%; it will take 4 years to pay back and will cost me $1,600 in interests)
#2. Bank of America $350 ( $6,500 at 15%; it will take 1.7 years to pay back and will cost me $900 in interests)
#3. Bank of America $215 ( $8,000 at 15%; it will take 4.1 years to pay back and will cost me $2,800 in interests)
#4. Prosper $450 ($5,500 at 16%; it will take 1.2 years to pay back and will cost me $550 in interests)

My plan is to use the 401K as a buffer by paying some of these loans, adding the left over money to my budgeted money to pay back my debt faster. This will reduce the amount of money I will have to pay my creditors. Also, note that I can only borrow around $10,000.

The loan
401K Loan will consist of $10,000, a 5 year loan at 5%, monthly payments of $190, interest will be paid to me and it will cost about $100 in fees.

With this loan I can consolidate loans #1, and #2, ($9,500 total; $450 monthly payments). This will eliminate $2,500 in interests.
Therefore $450- $190 = $270 to be used to pay off loan #4.

Loan #4 will be paid by means of $450 (currently budgeted) + $270 (buffered thanks to 401K) = $720 monthly payments. It will take 6 months to pay back and it will cost $185 in interest.

After 6 months, I can add the $720 to the currently monthly payments of loan #3. $720 + $215= $935.
Assuming that loan #3 will be at that point $7,500 at 15%, it will take 9 months to pay it back and will cost me $500 in interests. Right there I saved about $2,000 in interests by paying it faster.

Per this plan, it will take 14 months to pay off loan #4 and loan #3. It will free up $935 per month to pay back my 401k loan. I can't pay anymore than $180 per month to my 401K loan unless I pay in in full. So I will have to start putting that money into a savings account until I have saved enough to pay it back. it will take 9 months to save enough money at 3% apy.

Therefore, I can be debt free in (6+9) 15 months and will have to wait another 9 months to pay back my 401k loan. This is my plan to be debt free in two years.

I do side jobs and also receive good yearly bonuses, so this time can be shortened a little.

Pros.
Faster elimination of debt.
Peace of mind afterwards.
Save about $4,500 in interests

Cons

If I loose my job I have to pay it back in 3 months. The penalty, taxes will add up to around 30% = $3,000, which is still less than the $4,500 in interests.
Will loose growth power in the long term, IF there is a long term growth, right now it doesn't seem like this will occur. However this can be compensated by increasing my contributions once I don't have to pay credit cards and personal loans.

Options
Wait 1.7 years until loan #2 is paid off and use that left over money to pay off my other debt.

I am 80% sure that this is what I will do, but I would like to hear back from you guys. One thing to consider is that the peace of mind of being debt free is priceless.

Thanks for your advice,

F

[jIM_Ohio]

Borrowing from 401k will be realizing a loss. Bad idea on more than one level.

If you lose your job (in this market do not take employment for granted) you will owe taxes and penalties on the loan, or have to go deeper in debt to pay the loan off. You CANNOT finance your way out of debt.

If you can afford current payments, keep making them. I would fund 401k to the match and be patient. Quick fixes like 401k loans can cause problems.

[disneysteve]

I agree with Jim.

Essentially, you should NEVER borrow from a 401k. Just forget that option even exists. It is a BAD idea all around. If absolutely necessary, reduce your contributions to help pay down debt, but if you can contribute to get the full match and still make your debt payments, do that.

[scfr]

I currently make the following monthly payments, I could probably pay more but this allows me to have a comfortable lifestyle.


One thing to consider is that the peace of mind of being debt free is priceless.

I agree with Jim.

And I pulled out 2 of your sentences from different parts of your post.

Isn't the peace of mind of being debt free worth having a slightly less comfortable lifestyle right now? Wouldn't it even be worth having a slightly UNcomfortable lifestyle right now?

If I were in your shoes, I would scale back my lifestyle and focus on making larger monthly payments.

Good luck. Hope you keep us posted on what you do.

[jIM_Ohio]

OP is 23k in debt- that is not a lot.

I did not see an income or budget posted. But 23k in debt is something which can be addressed without much work or 401k loan or similar.

The OP should make sure 20% of his gross pay is either contributed to 401k or applied to his debt. That will fix problem quickly.

Making cuts to budget and applying 30%-40% of gross to debt would be even better.

[tripods68]

Don't do it! I agree with everyone here.

[simpletron]

just do a debt snowball with highest interest first. paying 1115(450+215+350+100) on 23K debt @21% takes 26 months to pay off, and it will be 1-3 months faster for you because not all debt is at 21%.

let me this this straight, you want to get double taxation, pay a 100 fee, lock in losses, and lose out on a possible future earnings.

also your 4500 savings is not really there. you just save the difference in interest. interest 21% on 10K over two years is 4641 and at 5% it is 1025 for a max saving of 3616(4641-1025). cost of double taxation at 25% marginal tax rate + fee is 3808.(you pay 3708 in taxes on 100 fee+11025(10K+5% interest over two years)). cost of double taxation at 15% marginal tax rate + fee is 2063.

[maat55]

I agree with scfr, if you truly want to be debtfree, sacrifice more for it. A strong desire can make big things happen. Put as much thought into cutting lifestyle as you put into your plan and you will find a great solution without borrowing from the 401k.

[Tico_75]

Thanks a lot for taking time and reading my post.

I am grateful for the constructive feedback and advice. I know this is a long post and maybe full of ramblings, but it is helping me a lot.

A little history....

Please note that I reduced my debt from $45,000 to $22,000 in about 3 years. Like the saying goes, it is cheaper to keep her. After this incident, I faced a “dark” period in my life. Nevertheless, I proudly can say that all is in the past and I moved forward.

I am simply sick of this debt and I want it gone asap. The aggressive way I am paying it back shows that I am committed and I am not just finding a quick fix. Also, I switched jobs three years ago and obtained a 25% raise, this helped me control and stop my debt.

In a few words, I am looking for the best strategy to get rid of this 23K pound gorilla.

Quoting jIM_Ohio

1. Get deeper in debt if I loose my job. Correct, I will face at least a 40% hit, but I am willing to take that risk in order to put this behind.

In case I switch jobs or God forbid I get laid off, I have 3 months to pay it back. I could take measures like selling my car or even getting another loan. This will not increase my debt as much as if I simply have to cash it in. It is a big risk, I know.


Quoting scfr

2. Comfortable.
I guess comfortable is not the appropriate word. Well, comfortable for me now is being able to pay my bills, buy food and know that I have a couple of hundred dollars left for clothing, maybe going out once or twice a month and assist my family in case of an emergency. It is only until this year that I have the feeling that things are under control and I can see the light at the end of the tunnel. By no means comfortable means that I am wasting money and burning it like a did years ago.

Quoting simpletron

Thanks for opening my yes into considering all debt as a whole; I will work on averages aprs and payments. I am going to review my spreadsheet.

A few things to point out.

Please note that the 5% apr on the 401k loan is paid to my account and not to Fidelity.

The 401K idea is to isolate or call it “freeze” one loan so I can use those payments to other accounts. It is risky, but I guess we all took chances on this life to succeed.

After reading this posts, I am getting a fuzzy feeling about taking 10K and will not borrow that much. The $6,500 at 5% will release about $250 to be applied towards debt reduction. The rest is all on the spread sheet and I can trust myself to get it done.

Note that all the debt, where it is 401K or loans will be paid with after taxes money no matter what, so that can be factor out of the equitation. Also, the way the market is right now, it doesn’t seem like I will be making any money there in a while. I could be wrong and I could loose on the rebound, true. But right now we all lost in average -20 % of our savings, 2 trillion in total and still going down.

I guess I am just venting my thoughts here. You guys are correct, this could backfire and I understand that it is risky. However, I really want to eliminate my debt as fast as I can.

I will consider all these options a little more,

Thank you,

F.

[noppenbd]

I ran your situation on the Debt Snowball calculator on What's The Cost? - Become debt free at WhatsTheCost.com. Try it out yourself at Snowball debt calculator - Become debt free at WhatsTheCost.com

Following a standard snowball (no 401k loan) you would be debt free in 24 months, and pay $3642 in interest. Here is how the snowball looks:

Nov 2008-Dec 2009 Payoff Prosper (extra 450 goes to US Bank)
April 2010 Payoff US Bank (450 + extra 100 goes to B of A #1)
May 2010 Payoff B of A #1 (550 + extra 350 goes to B of A #2)
October 2010 Payoff B of A #2
At that point you will be debt free. If you continue to invest $1115 a month in your 401k or IRA you will be looking good.

So your 401k plan will not be any quicker, and in addition will subject you to huge risks.

I would not take out the 401k loan.

[disneysteve]

Note that all the debt, where it is 401K or loans will be paid with after taxes money no matter what, so that can be factor out of the equitation.

The money currently in your 401k was put in before-tax.

If you borrow that money, you will pay it back with after-tax money.

In retirement, when you start drawing from your 401k, you will again pay taxes on that same money, meaning you will have been taxed twice on the same money.

That's why taxes are a factor in the equation.