Convince me not to get a 401K loan

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Affiron
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Convince me not to get a 401K loan

Post by Affiron »

I'm wanting to purchase a piece of property for my next home. The property I want to buy I think I can get for 100k. Currently 29, here is my situation:

401k Balance: 100k
ROTH IRA balance: 25k
Brokerage accounts+savings Emerency fund: 30k
Salary: 115k per year

I have a HELOC open with the full $55k avaialable for use.

I can get a 15 year lot loan at around 5.8%.

My Idea is to use 10K in cash, 55k in HELOC, and 35K in 401K loan (@ 5.25%) to pay cash for the lot and sit on it for the next 5 years until everything is paid off. Currently I live below my means and have around an extra 900/month for investing beyond my regular retirement savings. My savings might seem low given my salary, but I've only recently started making this within the last few years and my wife is a a stay at home mom.

Here is my logic on the 401k loan:

1) Markets made huge gains in the past year. Obviously we don't know if this will continue, but the best thing that could happen in this case is that I take a 401k loan at all time highs, and then the market drops and I dollar cost average in at discounted prices. As I also pay my HELOC balance down, should the market make a big drop, I can use the HELOC to pay off the 401k loan early, and buy back in at firesale prices.

2) Worst case, is that markets make huge gains, and I miss out on these gains for a couple years.

3) Another downside is that I lose some of the creditor and liability protection the 401k offers.

4) I will continue to contribute to my 401k to get employer match.

5) Lot loan is around the same rate, but obviously I'd be paying the interest to the bank.


What are reasons I should not do this?
Hyperchicken
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Re: Convince me not to get a 401K loan

Post by Hyperchicken »

Does you 401(k) plan allow making contributions while paying back the loan?
Topic Author
Affiron
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Re: Convince me not to get a 401K loan

Post by Affiron »

Hyperchicken wrote: Sat Nov 20, 2021 11:45 pm Does you 401(k) plan allow making contributions while paying back the loan?
Yes, and I intend to do so.
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JD Leonard
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Re: Convince me not to get a 401K loan

Post by JD Leonard »

Don't have the full picture so hard to say, but it sounds like you'd face significant hardship with respect to your loan obligations if you lost your job.

How much is your current property worth?

How much does your HELOC cost?

When would you build your next home and what would that cost?
Topic Author
Affiron
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Re: Convince me not to get a 401K loan

Post by Affiron »

JD Leonard wrote: Sat Nov 20, 2021 11:47 pm Don't have the full picture so hard to say, but it sounds like you'd face significant hardship with respect to your loan obligations if you lost your job.

How much is your current property worth?

How much does your HELOC cost?

When would you build your next home and what would that cost?
Thanks, yes that is a risk for sure if I lost my job.

Current property worth around 200k, owe around 105k.
HELOC is variable at 3.75%. In 1st year of 10 year draw period (interest only). In 10 more years, converts to 20 year amortized loan.

Next home would be built in 5-6 years after HELOC is paid down significantly and 401k loan is paid off. I get roughly a 10k bonus ever year (in addition to my salary), that I plan to put towards HELOC.

The plan is to build an affordable home in the 250k-300k range.
rightdecisions
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Re: Convince me not to get a 401K loan

Post by rightdecisions »

Pass.

You are young and your assets are low. Keep developing those investment/savings habits. Let your 401k grow with this market.
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Brianmcg321
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Re: Convince me not to get a 401K loan

Post by Brianmcg321 »

rightdecisions wrote: Sun Nov 21, 2021 12:28 am Pass.

You are young and your assets are low. Keep developing those investment/savings habits. Let your 401k grow with this market.
I agree. This is just a bad idea. Going into further debt and borrowing from your 401k. Just bad idea all around. It's obvious if you are having to do all of the shenanigans (heloc, 401k loan) in order to buy this lot, you simply can't afford it.
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exodusNH
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Re: Convince me not to get a 401K loan

Post by exodusNH »

Affiron wrote: Sat Nov 20, 2021 11:52 pm
JD Leonard wrote: Sat Nov 20, 2021 11:47 pm Don't have the full picture so hard to say, but it sounds like you'd face significant hardship with respect to your loan obligations if you lost your job.

How much is your current property worth?

How much does your HELOC cost?

When would you build your next home and what would that cost?
Thanks, yes that is a risk for sure if I lost my job.

Current property worth around 200k, owe around 105k.
HELOC is variable at 3.75%. In 1st year of 10 year draw period (interest only). In 10 more years, converts to 20 year amortized loan.

Next home would be built in 5-6 years after HELOC is paid down significantly and 401k loan is paid off. I get roughly a 10k bonus ever year (in addition to my salary), that I plan to put towards HELOC.

The plan is to build an affordable home in the 250k-300k range.
Be aware that banks can and will close down HELOCs during economically stressful times.

Have you actually talked with a building about the house you want to build? $250k for a custom build doesn't seem like a lot.

It feels like you're way over leveraging.
hachiko
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Re: Convince me not to get a 401K loan

Post by hachiko »

Do you understand the pitfalls of a 401k loan already? Like double tax on interest, possible full repayment if you lose your job (I think this is dependent on the plan), loan fees charged by the administrator.

I'm not as opposed to 401k loans as others, but I would choose the lot loan over the 401k loan here simply because of the double tax on interest and other fees.
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markjk
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Re: Convince me not to get a 401K loan

Post by markjk »

Affiron wrote: Sat Nov 20, 2021 11:41 pm What are reasons I should not do this?
Your logic is sound. The biggest reason to not do it is the loss of compounding on the 35k for however long it's out of the 401k. You will be paying yourself back which is great, but you will lose out on some compounding if the market appreciates. You'll also lose out on whatever dividends that 35K would have produced. Of course this isn't linear since you will be paying it back over time and who knows what the market will do. But in the end, the chances are you will have less in your 401k over time. How much less? Can it be offset with appreciation on the property? Even if it's not offset, is it still worth it to you because you love the new property? etc. etc. This really comes down to a personal choice on how you want to spend your money.

In general I'm not a fan of pulling money from a 401k to buy something. However, in this case it is property which can be considered an investment by itself. If someone is going to pull from a 401k, this seems like a reasonable reason to do it. I still don't think I'd do it personally, but I also can't fault you for doing it if it's the right thing for you at this point.
London
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Re: Convince me not to get a 401K loan

Post by London »

I don’t see any issue with it for short term liquidity. Go into it with your eyes open on some of the points raised above. But it can be great in a declining market as your effectively shorting a portion of your portfolio.
dknightd
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Re: Convince me not to get a 401K loan

Post by dknightd »

I would never borrow against my retirement accounts. To do that admits you are trying to save too much
If you value a bird in the hand, pay off the loan. If you are willing to risk getting two birds from the market, invest the funds. Retired 9/19. Mortgage payed off 5/21. I have some 0% loans to pay off.
TJat
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Re: Convince me not to get a 401K loan

Post by TJat »

I hope you come to realize this is a bad idea. At your age, time in market is your most important investment decision. So keep your 401k intact.

If you must take a loan, get it from the bank. It’s not clear why you need to buy land 5 years in advance of building an additional property, bleeding out property taxes. Why not rack up more savings for 5 years and move into a new home then?
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Nate79
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Re: Convince me not to get a 401K loan

Post by Nate79 »

This is the very definition of doing something you can't afford.
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winterfan
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Re: Convince me not to get a 401K loan

Post by winterfan »

Why would you sit on the lot for 5 years? What do you think the value of the land will be then? Why not save up the money instead and buy it when you are ready to move?
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whodidntante
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Re: Convince me not to get a 401K loan

Post by whodidntante »

I'm an advocate of a 401k loan in far more situations than the average Boglehead, but it just seems like you are speculating to me.
tashnewbie
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Re: Convince me not to get a 401K loan

Post by tashnewbie »

I just don’t get why you’d go through all this maneuvering to build a home that’s “only” worth $50-$100k more than your current home.

Does that extra money get you much better quality or other features in your area?

Why not just buy a new home in that range?

Do you just have a really strong attraction to this lot? Is it unique?

I wouldn’t want to leave the lot vacant for 5 years. You’d have to check your local laws to see what you may need to do with the lot while it remains undeveloped.

I’d skip this idea. Sell your current house and buy another house if that’s what you really want.
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abuss368
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Re: Convince me not to get a 401K loan

Post by abuss368 »

Based on the information provided I would pass. Raw land is a whole different transaction. I would continue to build your cash and investments as you continued o pay down debt.

* No income from the land. Only expenses such as insurance and taxes.

* There is speculation here.

* What if the area changes and the land decreases in value. Schools, developments, industry, roads, and so forth are outside of control.

Best.
Tony
John C. Bogle: “Simplicity is the master key to financial success."
invest4
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Re: Convince me not to get a 401K loan

Post by invest4 »

Brianmcg321 wrote: Sun Nov 21, 2021 12:44 am
rightdecisions wrote: Sun Nov 21, 2021 12:28 am Pass.

You are young and your assets are low. Keep developing those investment/savings habits. Let your 401k grow with this market.
I agree. This is just a bad idea. Going into further debt and borrowing from your 401k. Just bad idea all around. It's obvious if you are having to do all of the shenanigans (heloc, 401k loan) in order to buy this lot, you simply can't afford it.
Also agree. Personally, I can not imagine borrowing from my 401k unless something has seriously gone wrong. YMMV.
luckyducky99
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Re: Convince me not to get a 401K loan

Post by luckyducky99 »

Agree with others that say to pass. The source of funds isn’t the issue for me. It’s more that spending that much of your liquid net worth on a piece of property that you won’t do anything with for 5 years is just too risky. Lots can happen in 5 years; this is basically real estate speculation.
LittleMaggieMae
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Re: Convince me not to get a 401K loan

Post by LittleMaggieMae »

The property I want to buy I think I can get for 100k
What makes this plot of land so special that it's worth 100K?
The plan is to build an affordable home in the 250k-300k range.
Why would you build a 250K to 300K house on what would seem to be such a spectacular piece of property? I suspect your neighbors will be building much bigger and more expensive houses.

Have you thought about all the expenses that go with building your own home on land you purchased? Like water and electric and sewerage and roads and then possibly drainage. The house you build might be 250k to 300K but I suspect that doesn't include water/electric/sewerage/and roads to your new house.

With the information you've provided - this doesn't look or feel like a plan that will end well. If you must buy the property I would not use a 401K loan as a part of the financing.
rascott
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Re: Convince me not to get a 401K loan

Post by rascott »

I rather doubt you can build anything desirable for $250k on a raw piece of land. You'd better really check those numbers.
VoiceOfReason
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Re: Convince me not to get a 401K loan

Post by VoiceOfReason »

Affiron wrote: Sat Nov 20, 2021 11:41 pm
My Idea is to use 10K in cash, 55k in HELOC, and 35K in 401K loan (@ 5.25%) to pay cash for the lot and sit on it for the next 5 years until everything is paid off



What are reasons I should not do this?
1) Your are trying to justify this in part by recent market performance. You are in essence trying to time the market. This is not advisable and should not be factored in.

2) You have very few assets. Would be highly leveraged with 2 properties. Would be in big trouble with job loss, economic downturn (which you are oddly counting on) or any type of adverse health event.

3) You want to sit on the property for 5 years then build? You are 29 and will be 34 before even building? Ask people you know how much their life changed from 29 to 34/35. Marriage, kids, jobs, etc. There may be factors that make this property entirely unattractive to you in 5 years.

4) Do you have ALL the 401k plan details and have you asked more than one person?

Bottom line, I’m not opposed to 401k loans. I think they can be a useful tool for someone with SIGNIFICANT assets trying to purchase a 2nd property and do t want to trigger capital gains taxes by selling off taxable brokerage $$. You are not doing that. You have low assets and actually need the 401k $ to do the transaction.

This is ill advised all around and wreaks of a young person just getting anxious to do something.
260chrisb
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Re: Convince me not to get a 401K loan

Post by 260chrisb »

Affiron wrote: Sat Nov 20, 2021 11:41 pm I'm wanting to purchase a piece of property for my next home. The property I want to buy I think I can get for 100k. Currently 29, here is my situation:

401k Balance: 100k
ROTH IRA balance: 25k
Brokerage accounts+savings Emerency fund: 30k
Salary: 115k per year

I have a HELOC open with the full $55k avaialable for use.

I can get a 15 year lot loan at around 5.8%.

My Idea is to use 10K in cash, 55k in HELOC, and 35K in 401K loan (@ 5.25%) to pay cash for the lot and sit on it for the next 5 years until everything is paid off. Currently I live below my means and have around an extra 900/month for investing beyond my regular retirement savings. My savings might seem low given my salary, but I've only recently started making this within the last few years and my wife is a a stay at home mom.

Here is my logic on the 401k loan:

1) Markets made huge gains in the past year. Obviously we don't know if this will continue, but the best thing that could happen in this case is that I take a 401k loan at all time highs, and then the market drops and I dollar cost average in at discounted prices. As I also pay my HELOC balance down, should the market make a big drop, I can use the HELOC to pay off the 401k loan early, and buy back in at firesale prices.

2) Worst case, is that markets make huge gains, and I miss out on these gains for a couple years.

3) Another downside is that I lose some of the creditor and liability protection the 401k offers.

4) I will continue to contribute to my 401k to get employer match.

5) Lot loan is around the same rate, but obviously I'd be paying the interest to the bank.


What are reasons I should not do this?
Reasons not to; you're 29 and are off to a very good start and will compromise it, you're not actually certain of the actual purchase price, you're likely trying to find a creative way to buy something you can't yet afford (and it's okay to admit it), and you're likely setting yourself up for a completely different thought process and approach to saving and investing. IMO; one should never borrow from a 401K unless it's life or death or maybe a foreclosure. You make good money, save the money for this purchase and keep your 401K for what it's designed to be; a retirement and wealth building tool. Don't do it!
folkher0
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Re: Convince me not to get a 401K loan

Post by folkher0 »

Affiron wrote: Sat Nov 20, 2021 11:41 pm 2) Worst case, is that markets make huge gains, and I miss out on these gains for a couple years.
Worst case is that you lose your job. The terms on many 401k loans stipulate that if you are no longer employed with the sponser of the 401k, the entire balance of the loan comes due within a short interval of time. IMO, not worth the risk, in your case.

I actually like the idea of 401k loans as a way to smooth out the cost of big purchases over a few months. But I wouldn't take out a loan for an amount larger than I already had access to in liquid accounts.
michaeljc70
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Re: Convince me not to get a 401K loan

Post by michaeljc70 »

It sounds like you are borrowing $90k and can pay back $900/mo. That means it would take over 8 years to pay this off. That is a long time given the risks of a 401k loan. Do you expect this land to shoot up in value? If not, why tie up $100k for years to sit unused while paying interest?
mdavis6890
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Re: Convince me not to get a 401K loan

Post by mdavis6890 »

Unless there is something particularly special about this particular lot, it’s a bad idea.

If there is something special about it, I think you can do it, but you’ll really have to tighten up your budget and pay off the debt faster than $900/mo while maintaining your retirement contributions. Is it worth giving up the rest of your lifestyle for this lot? Maybe it is, maybe not.

You also have to see that this is a big gamble that can work out well, or very poorly. You can lose your job and get killed on taxes for the “loan” that becomes income you didn’t plan for. Worse than that, the market can cool a lot putting you under water on it and destroying equity in the home you already have.

Good luck, whatever you decide!
newacct
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Re: Convince me not to get a 401K loan

Post by newacct »

hachiko wrote: Sun Nov 21, 2021 8:10 am I'm not as opposed to 401k loans as others, but I would choose the lot loan over the 401k loan here simply because of the double tax on interest and other fees.
Your so-called "double tax on interest" simply describes a feature that all loans have (i.e. the borrower pays the interest with after-tax funds, so pays 1x tax on money they do not get to keep). It is not specific to 401k loans.
newacct
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Re: Convince me not to get a 401K loan

Post by newacct »

folkher0 wrote: Tue Nov 23, 2021 9:00 am Worst case is that you lose your job. The terms on many 401k loans stipulate that if you are no longer employed with the sponser of the 401k, the entire balance of the loan comes due within a short interval of time. IMO, not worth the risk, in your case.
However, starting in 2018, you have until the tax filing deadline (April 15 of the next year) to rollover the distribution from defaulting on a 401k loan due to losing your job, into an IRA.
Williams57
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Re: Convince me not to get a 401K loan

Post by Williams57 »

Why not just get a mortgage, even for conventional if not eligible for FHA you can get it with less than 20%. Then you get to enjoy the house now.

The reason I say this is because we're in an inflationary environment, why wouldn't one get a mortgage at 3% when the inflation for this year to date is over 6%? You sound like you live within or below your means, so I'm not worried about you buying something you can't afford.

Unless I'm missing something and the above is impossible to do?
Northern Flicker
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Re: Convince me not to get a 401K loan

Post by Northern Flicker »

Affiron wrote: 5) Lot loan is around the same rate, but obviously I'd be paying the interest to the bank.
It does not matter to whom you pay the interest. If you take a 401K loan, you may be paying interest to yourself, but you are giving up the opportunity of loaning out the money to one or more entities that will pay you interest.

As an example, if you buy bonds paying 3% with the 401K funds and borrow at 3% from a bank, you are paying out 3% interest on your loan, and your 401K is earning 3% interest, the same as if you borrowed from the 401K at 3% interest.

But you probably prefer to invest it differently than 100% bonds, so the 401K loan does little more than lock you in to a plan that simulates allocating the 401K assets at 100% bonds.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
CurlyDave
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Re: Convince me not to get a 401K loan

Post by CurlyDave »

Affiron wrote: Sat Nov 20, 2021 11:41 pm
...What are reasons I should not do this?
This is way, way too risky for me.

And to give you an idea of my risk tolerance, I was 100% stocks in my 401(k), until I retired when I rolled it over to an IRA which I kept at 100% stocks for the first 12 years of retirement. I am still at 85% stocks.

They will still be selling lots and houses in 5 years. Wait and pick a nice one then.
Answering a question is easy -- asking the right question is the hard part.
folkher0
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Re: Convince me not to get a 401K loan

Post by folkher0 »

newacct wrote: Tue Nov 23, 2021 11:32 pm
folkher0 wrote: Tue Nov 23, 2021 9:00 am Worst case is that you lose your job. The terms on many 401k loans stipulate that if you are no longer employed with the sponser of the 401k, the entire balance of the loan comes due within a short interval of time. IMO, not worth the risk, in your case.
However, starting in 2018, you have until the tax filing deadline (April 15 of the next year) to rollover the distribution from defaulting on a 401k loan due to losing your job, into an IRA.
Didn't know this. However it would seem to imply that instead of potentially defaulting, you wold instead pay taxes as well as penalty on the disbursement. Not sweet, especially in a situation where you've just lost your job.
Onlineid3089
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Re: Convince me not to get a 401K loan

Post by Onlineid3089 »

Is this property a lot in a town, or is this something more along the lines of an acreage out of town?
esteen
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Re: Convince me not to get a 401K loan

Post by esteen »

Nate79 wrote: Sun Nov 21, 2021 9:59 am This is the very definition of doing something you can't afford.
This was my first thought.

“There are two ways of being happy: We may either diminish our wants or augment our means — either will do — the result is the same.” - Benjamin Franklin

Just learn to stop wanting, that will solve your problem and make you happy without any 401(k) loan.
This post is for entertainment or information only, and should not be construed as professional financial advice. | | "Invest your money passively and your time actively" -Michael LeBoeuf
hachiko
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Re: Convince me not to get a 401K loan

Post by hachiko »

newacct wrote: Tue Nov 23, 2021 11:26 pm
hachiko wrote: Sun Nov 21, 2021 8:10 am I'm not as opposed to 401k loans as others, but I would choose the lot loan over the 401k loan here simply because of the double tax on interest and other fees.
Your so-called "double tax on interest" simply describes a feature that all loans have (i.e. the borrower pays the interest with after-tax funds, so pays 1x tax on money they do not get to keep). It is not specific to 401k loans.
True, I agree and stand corrected. I was thinking about it the wrong way. Though this was not what I was thinking about when I posted that, I wonder how the interest paid into the 401k is treated in a Roth 401k.
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sunny_socal
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Re: Convince me not to get a 401K loan

Post by sunny_socal »

Taking a 401k loan is not a mistake. It is a mistake to not pay that loan back....
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