Friday, July 20, 2012

Decision: student loan or 401k loan?

Dear readers, I have a question that I can't decide, and I'm hoping I can solicit your feedback.

As you know, I have around $19k of student loans outstanding. I also have a loan against my 401k, which in my pre-Mustachian days I took to scrape together a down payment for my house. Well, suddenly I find myself with enough cash to cover the 401k loan, and I'm wondering: should I close out my 401k loan, or should I toss all that money at my student loan?

Here's some more background:

After last month's student loan payments I was light on cash. Then I hear from my company's HR department that accounting had made a mistake processing my 401k loan paperwork last year. As I think I mentioned before, in addition to the loan I took a hardship withdrawal (yeesh, I really wanted this house). The terms of a hardship withdrawal are such that you can't contribute to your 401k (or get company matching contributions) for six months. Except that somehow their communication wires got crossed between the HR department and the 401k company, and they kept my payroll contributions flowing. The way the 401k company rectified this situation was to cut me a check for the amount of money that I shouldn't have been able to contribute for that six months.

Yes, it sucks that I missed out on six months of 401k contributions, and six months of company matching contributions. I made that decision and I'll accept the consequences. But the silver lining is that I've got an extra $2400 cash that I can use to pay down debt.

The total balance in my cash accounts is $5100. In addition to the $2400, I've been setting a few hundred dollars aside per month both as a cash buffer and so that I could pay off my 401k loan. There's about $3200 outstanding on the 401k loan, and I need to pay it off all at once by sending a certified check.

But now that I'm looking at all this cash in my account, I'm visualizing taking my student loans down from $19k to near $14k, and it looks pretty good!

The interest rate on my 401k loan is 4.25%, which I'm paying with after-tax dollars back into my 401k account. The payments are $38.91 twice a month, with a five-year term that I'm about 14 months into. So the increased cash flow would be small. There is a $50 "maintenance fee" charged once a year, so that's a reason to pre-pay this loan, but it's already happened in May so I won't get hit again until next May.

Basically the choice is between a debt snowball approach and a highest-interest-rate-first approach. In recent weeks I've been leaning toward just sending all but a few hundred dollars to pay off the student loan.

What do you think? One fewer loan to think about, or 25% off of my student loan?

10 comments:

  1. Not running the math, I'd probably pay off the 401K, and put any left over to the student loan. I dislike having little bits of payments to worry about.

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  2. 2nd the thoughts to just kick the 401k loan to the curb. Even without doing a fancy algebra problem, I think you'll get a nature high from knowing that you have totally knocked off one liability from your personal balance sheet. So therefore I vote for the debt snowball approach on this one. [Now put you hand on something you believe in and swear to never borrow money from your 401k again!]

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  3. I'm for the debt snowball approach too. Get rid of that 401k loan.

    Here's why I think this: most of that money you've got was sent to your 401k originally anyway, so just send it back to your 401k company to repay the loan. Get rid of this debt and you can. Turn your attention, once again, to your student loans. As Willhelm said, I think you'll get a natural high from getting rid of another debt.

    Might I request a post detailing all of your debts (including the mortgage) and how you plan to address them?

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    1. Good idea on the debt post. I'll plan one for the next week or so; probably it will include the 401k loan since it'll take some time to get the paperwork through. Now that I've got 0% credit card debt building up I can't let myself forget what position I'm in.

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  4. 4th vote for debt snowball approach. It feels good to kill loans!

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  5. The answer actually depends on the purpose of the loan. It's best to consult a financial adviser about this.

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    1. I'm not so sure! I think my awesome commenters are more valuable than any financial adviser. Cheaper, too!

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  6. Pay off the 401(k) loan. The feeling of ridding yourself of one debt is worth a lot.

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    1. Thanks, everyone, for your advice. I've decided to go with the 401k loan. More details in my next post!

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