Bank versus 401-K Loan Calculator

Bank Loan versus 401-K Loan Comparison

A 401-K balance is portable and if you leave your employer you have the option of rolling the funds over into an IRA, or into a new employer’s 401-K plan. However 401-K loans are not portable (someone should lobby the US congress to make them portable!) and one is required to pay it back in a short period (typically 60 days) or pay taxes and penalties on unpaid loan balances.

[Since my earlier post I have sent a letter to my representatives in the US Congress and Senate to consider making 401-k loans portable. Attached is a copy of my letter in pdf and one in microsoft word– feel free to use this as a template if you want to send a similar request to your representatives].

So read on only if you are sure that you will not leave your employer over the time-frame of your loan or if you are confident about finding funds to repay the loan within the 60 days or so timeframe specified by your plan.

When you take a loan from your 401-K you draw down your balance and any interest and principal payments on the loan go back into your 401-K. So you lose or forego what you might have earned if you had not drawn down your 401-K netted against the gain of the interest payments and the compounding within your 401-K of your monthly principal and interest payments.

When you take either a bank loan or a 401-K loan you forego what you might earn if you choose to save the monthly loan payments instead of making the purchase or spending for which you needed the loan. Most people park money outside 401-K in bank accounts, CDs and money market accounts, serving typically as a quickly accessible secure cash surplus for emergencies. So when comparing bank loans with 401-K loans one also needs to think of funds foregone when a loan is taken. The amounts foregone would differ for the bank loan and the 401-K loan as the monthly payments are likely to differ.

So one needs to add the net worth foregone inside 401-K and the net worth foregone outside 401-K to get an estimate of the total cost of the two options being considered.

The default numbers in my spreadsheet are a 3% interest rate outside 401-K (as I noted earlier this tends to be accessible secure cash which typically earns less interest), a 7% interest rate on 401-K investments, an 8% interest rate on a bank loan (Bank loans are typically more expensive, especially when not backed by collateral), a 6% interest rate for the 401-K loan (401-K loans tend to have lower rates as you bear your own risk), a $10,000 loan amount (the IRS limit is 50% of the vested account balance up to a maximum of $50,000) and  a 48 month term (IRS requires that the loan should be repaid in 5 years, unless used to buy the participant’s main home).

For the default numbers in the spreadsheet there is a net gain of $217.95 of the 401-K option compared to the bank loan and a percent gain of 2.18%. These, the monthly payments and the calculations of net worth foregone are in the bottom box of the spreadsheet.

Edit the blue cells in the spreadsheet and enter your data and the calculations in the bottom box of the spreadsheet will refresh. 

Painted 30 egg, egg carton.