Have a 11k equity loan. . Should i borrow from my 401k to pay off this little amount or wait?

Question

in 2004 I bought a condo. 2006, my family grew and I needed to upgrade to a larger single family home. I borrowed a fixed payment 71k equity loan (9.5% interest) from the condo to use as down payment for the new single family. currently, the condo is getting rented out (the rent is convering the mortgage payment so it is turning out even) and I have also paid down the equity loan to 11k using my bonus. However, I want to pay off this equity loan sooner, because even though I paid the equity down quite a bit there is still a fixed payment of $500 that I have to pay each month until the loan is extinguished. From my estimates I wont fully pay it off until the end of 2007. Should I borrow from my 401k and pay off the equity loan already? Or should I just wait till the end of the year and use my bonus. I figured paying off the equity now can increase my cash flow.

Also, do you think I can get tax exempt for withdrawal for paying off this equity since it was from my first home.

Answer 1

Either way it is a loan!!!! no the interest on the home loan can be at least taken to your tax return>

Answer 2

As others have said do not withdraw from your 401k. If you have a cash flow issue I would suggest asking your bank to roll the equity loan into an equity line of credit. Most equity lines require interest only payments which would substantially decrease the required monthly payment to less than $100 based on current rates. Be aware that the interest rate will be adjustable but because it's such a small amount and short term rates may go down later this year it's not that big of a deal. While this will free up some cash flow for you I would still encourage you to pay down the principal balance of the equity line as quickly as possible.

Answer 3

Typically I'd say no it's not worth it. But, if your 401k performs under the 10.25% that you'd be paying yourself then it's ok. If your 401k outperfms that 10.25% number then you're hurting yourself. What you pay in interest on the equity loan is a factor but minor in comparison to the long term impact on your 401k. In reality? I'm guessing that your income level is sufficiently high that the true cost to your account won't be felt. We really are talking only about $1,000 difference to your account over the next 2 years if the market earns 15%. But that 1k can never be recovered...and will only be magnified over the next 30 years. So...big question is how do you think the market will go over the next 24 months.

The mere fact that you can use bonus to pay it off in a year tells me to do that...and then bump up your 401k deposits that $500/month at least for the remaining year. THAT would be in your best interests.

and no, no exemption for a withdrawal to pay off the equity. You only get that exemption if it's 1) from an IRA and 2) used to PURCHASE the home not make a payment.

And what you can't do under any circumstances is spread out the payments over a longer period then what you currently owe. You're really talking only about a short term bet on the market.

Answer 4

You didn't mention where you live, and tax conditions there matter. You should put the money where it creates the best after tax return, given the risk levels you're willing to take. You don't appear to have any high-interest debts, which are a no-brainer to payoff (for someone with credit card debt, they might be paying 20% a year on it ... after tax. Paying down credit card debt is 'as good' as an investment with a guaranteed _after tax_ return of 20% ... good luck finding an investment like that!). For me, I'd probably pay down my home equity, but my understanding is that in the US you can claim interest on a mortgage as a tax deduction? Given that, it may make that less appealing. Is there any tax deduction for the interest on the 401k loan? In canada, I can claim interest on debt used to finance investment against those investment gains, but on tax sheltered retirement savings, I don't think you can ... so that might be the best thing to pay off first? I don't know. Look at the interest rates, and take into account tax impacts. The interest rate on car financing is often so low that you'd be better off investing the money - at this point. When you originally purchased, you probably could have gotten cash back instead of a good financing rate, given you took the rate, you might as well use it.

Answer 5

I agree with the others. Do not borrow from the 401k. You could look at getting a better rate on the line of credit. There are some banks that offer no fees and if you can get a better rate that would help.

Answer 6

No, Never. You will pay ordinary tax on what you take out of your retirement account which is what percent? You lose this. Then you pay a 20% penalty which is what percent? You get to deduct the 9.5% interest so you're not really paying 9.5%. Taking money out of retirement accounts is almost never a good idea. Also, if it's just bothering you that you're paying 9.5% and you want peace of mind, you're an idiot! Don't throw away money! Don't do it!

Answer 7

Never, never never take a loan from your 401k. That's the rule, and you should stick by it. It doesn't matter what the circumstances are that you list.