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Using 401k to pay off student loans


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Just saw this article about how this guy (who makes 6figures) paid off his student loans in 7 months. He took a big chunk out of his 401k to do so. The thinking was that he saves 40K in interest from paying his student loan in full. Which got me thinking...

C has about 17K in SL. We're 31.  Do you think this would be a dumb move for us to do, even though we have about 20+ years to keep saving?

Or, should we keep saving $17K in a cd or what not and pay the big lump sum when we are ready to do so? I feel this would be much better to do, because I don't think we can pay towards principle only on his loans. All over payments go to the combined interest and principle amount (complete, and utter* rip off!).

Thoughts?

 

*is that the right spelling?

14 Replies (last)

how much is the interest on the loan? how much could you conceivably make in this & future markets?

knowing 0 about american student loans or 401ks (uniquely american) - dunno, would probably pay off the loan to head off the interest, since, as i've learned, you can't shake it, ever.

(yes, 'utter' is right :) )

Unless I am missing something, that is a terrible strategy.  In addition to a penalty for early withdrawal, your 401k earnings will be taxed at probably 15-25%.  So, you are paying 15% to save 8%.  Doesn't make a lot of sense to me.

But otherwise, yes, paying down the principal on your student loans is a good idea.  You're better off just paying extra each month instead of saving up a bunch to pay at once, because you'll pay down the principal faster, and that means less interest over the life of the loan.

You probably have to do something to specify that you're paying extra on principal.  I'm not sure if you can make a notation in the memo field or if you need to call and tell them that's what you're doing.  If you're not careful then they just credit it against the next payment that you owe without every giving you credit for the advance payments.

Well he makes 6 figures and I dont...If i'd make 6 figures I might be able to pay my 40,000+ student loans in 7 months (jk)

There's a big difference between taking a withdrawl from your 401k and taking a loan out from your 401k, if your employer allows you to do that.  As someone stated above, taking a withdrawl you will incur early withdrawl penalties as well as taxes at some high rate.  Taking a withdrawl is a big mistake and should be avoided. 

I work for a large employer in the midwest (75,000 + employees) that allows us to take loans out from our 401k.  I think there's a limit from $1,000 to $50,000 total loan amount.  We set up our own re-payment plan (12, 24, 36 months, etc) that we need to pay back into our accounts.  We do pay interest on the loan, which is currently about 3.4% (last time I checked), but the beauty of it is that the interest we pay goes directly into our own accounts.  So not only are we paying the original principal back into our accounts over time, but we're also paying ourselves interest.  Much better than taking a loan from a bank and paying interest to the bank.  The down side is that you'll lose out on any investment return in the amount you borrow, but with today's economy I'm not sure anyone's 401k is doing that great anyway.  Just need to look at the numbers and see what's the best option for you. 

 

To me it makes sense if I have a $3000 credit card balance with a 12% interest rate, to take a loan out from my 401k and pay the credit card off. 

 

Okay. I figured the 401k thing was dumb.Now it's confirmed.

C's student loans don't allow for principle only.  When we pay towards Principle, we still have to pay the monthly accrued interest rate, even if we pay our minimum monthly payment when due.

That's why I thought, we might as well pay the minimum (144; interest rate is 2.75%), and save 17k to put towards the loan at one time. It just seems that adding to principle is just treading water. Plus, we'll earn .90% with our account. I know we're paying more interest in debt than savings, but...

Can anyone tell me how to figure out how long it will take to pay off the loan adding $50 extra a month (going to principle and interest), the minimum of $144 (paying towards principle and interest), if our loan is 17K with a 2.75% rate?

 

Just google any loan calculator.  It'll break down the amortization and the total interest payments for you for any payment amount or time period you put in.

Original Post by mjsophia:

C's student loans don't allow for principle only.  When we pay towards Principle, we still have to pay the monthly accrued interest rate, even if we pay our minimum monthly payment when due.

That doesn't click with any loan I've ever heard of. My car loans, student loans, and mortgage take any overpayment and apply it to the principal. What happens if you pay $50 extra?

Original Post by cnichols2000:

Original Post by mjsophia:

C's student loans don't allow for principle only.  When we pay towards Principle, we still have to pay the monthly accrued interest rate, even if we pay our minimum monthly payment when due.

That doesn't click with any loan I've ever heard of. My car loans, student loans, and mortgage take any overpayment and apply it to the principal. What happens if you pay $50 extra?

For some reason, we cannot increase our minimum payment to include a "principle only" payment. We pay $144 every 6th of the month; that equates to about $30 in interest and the remainder for principle. 

But, my husband thinks that the interest acurred after the 6th is deducted from the interest due in the next month (not sure). 

Anyways, each time we pay, a portion goes to interest.

Original Post by mjsophia:

Okay. I figured the 401k thing was dumb.Now it's confirmed.

C's student loans don't allow for principle only.  When we pay towards Principle, we still have to pay the monthly accrued interest rate, even if we pay our minimum monthly payment when due.

That's why I thought, we might as well pay the minimum (144; interest rate is 2.75%), and save 17k to put towards the loan at one time. It just seems that adding to principle is just treading water. Plus, we'll earn .90% with our account. I know we're paying more interest in debt than savings, but...

Can anyone tell me how to figure out how long it will take to pay off the loan adding $50 extra a month (going to principle and interest), the minimum of $144 (paying towards principle and interest), if our loan is 17K with a 2.75% rate?

 

2.75% is such a low rate.  Any other loan you could get would be at a higher rate.  Even if you borrowed the money from a 401(k), you'd be looking at 4-6%, so that would be a bad option.  Plus you'd be risking your 401(k) money for no good reason.  If you were to lose your job while you had an outstanding 401(k) loan, you would have to pay up the entire balance that you owe immediately or face the early withdrawal penalty and higher taxes.  So that would be terrible.

At $144 a month, it will take you 10 years to pay it off at a total cost of $2400 & change in interest.  You could shave 4 years and about $300-330 off that by saving the $50 extra to pay it off early.

But do you have 6 months of living expenses saved up?  If not, I would put the $50 extra or whatever you can, aside for your emergency fund in case of job loss.

Then, after you accumulate a 6 month emergency fund (which you will *never* touch unless you lose your job and have no other way to pay your bills) I would start saving in a rainy day fund.  That would be to cover unexpected expenses like a major car repair or a leaky roof.

And after that, I'd re-evaluate my income and expenses and if I have extra for saving, I'd come up with a plan.  I say all of this based on listening to Clark Howard on the radio. I love him. 

If you do have a 6 month emergency fund, and a rainy day fund, then go to Clark's website - he's got all kinds of helpful tips for the best things to do with your money.

:)

(edit - corrected the numbers)

Original Post by nomoreexcuses:

Original Post by mjsophia:

Okay. I figured the 401k thing was dumb.Now it's confirmed.

C's student loans don't allow for principle only.  When we pay towards Principle, we still have to pay the monthly accrued interest rate, even if we pay our minimum monthly payment when due.

That's why I thought, we might as well pay the minimum (144; interest rate is 2.75%), and save 17k to put towards the loan at one time. It just seems that adding to principle is just treading water. Plus, we'll earn .90% with our account. I know we're paying more interest in debt than savings, but...

Can anyone tell me how to figure out how long it will take to pay off the loan adding $50 extra a month (going to principle and interest), the minimum of $144 (paying towards principle and interest), if our loan is 17K with a 2.75% rate?

 

2.75% is such a low rate.
Very True...actually I found out it's 2.6525 :)

Any other loan you could get would be at a higher rate.  Even if you borrowed the money from a 401(k), you'd be looking at 4-6%, so that would be a bad option.
True.

Plus you'd be risking your 401(k) money for no good reason.  If you were to lose your job while you had an outstanding 401(k) loan, you would have to pay up the entire balance that you owe immediately or face the early withdrawal penalty and higher taxes.  So that would be terrible.
Double True.

At $144 a month, it will take you 10 years to pay it off at a total cost of $2000 & change in interest.  You could shave 2 years  and about $200-250 off that by saving the $50 extra to pay it off early.
I just hate having 10 year of debt, but we have other expenses ahead of us, and like you said, 2.6525% interest is fantastic.

But do you have 6 months of living expenses saved up?
Yes, Plus money for a Down Payment on a house (we're renting the condo and staying at my moms while we "shop". I think we may have found one, too :)

 If not, I would put the $50 extra or whatever you can, aside for your emergency fund in case of job loss.
So far, we're not putting anything towards the SL, so that we can save more money for our loan requirements. with the debt of the condo and SL the banks advised us to have more cash than to pay down debt. Once we're settled in a home, we'll start putting extra$$ towards the SL again.

Then, after you accumulate a 6 month emergency fund (which you will *never* touch unless you lose your job and have no other way to pay your bills) I would start saving in a rainy day fund.  That would be to cover unexpected expenses like a major car repair or a leaky roof.
Emergency savings would cover every expenses we have in the book, right? I don't think we have that much (after buying a house and owning a condo), but we have enough for if the renters bail, or one of us loses a job. I think that should be okay, right?

And after that, I'd re-evaluate my income and expenses and if I have extra for saving, I'd come up with a plan.  I say all of this based on listening to Clark Howard on the radio. I love him.  If you do have a 6 month emergency fund, and a rainy day fund, then go to Clark's website - he's got all kinds of helpful tips for the best things to do with your money.

:)
Thanks Nomo. Our plan is to act as if we make $10k or so less a year to put to savings/investing. Still have no idea how to invest, but our accountant referred us to someone for when we're ready.

 

 

Cool!

Clark Howard has lots of advice for investing too, especially for beginners - he has a list of the best funds (lowest cost to you) at the different risk levels depending on how long til you retire.

Sounds like you guys are on track!

What about using an High Early Cash Value Whole Life Insurance Policy?  I had a guy try to sell me on this to help save/pay for kids' education, but I wonder if it can be used to pay down my own student loan.  Anyone know if that is a viable option?

Dude.  Whole life??? Don't fall for that.

HECV insurance just means you pay a monster premium up front.  If you've got that kind of money, chances are you're better off paying it toward your student loan now rather than putting it in a junk investment that might give you a 5% return in thirty years.  Don't forget that any gain on the "investment" portion of your insurance policy is going to be taxable. 

Pretty much anything involving buying whole life insurance is going to be a bad deal for you.

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