Dear Dr. Don,
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I am putting in a swimming pool and need $20,000 to finish the project. I have several options to choose from: a regular bank loan at 7.15% for three years; a 401(k) loan at 3.5% for three years; or take the money out of savings and not owe anything. I know rates are really low right now, so a loan may be the best choice. I am just not sure which way to go. We do not have any debt except for our house payment, but money is still a bit tight at times. Help!
- David Diver
Skip the bank loan. There's no way you want to be paying more than 7% on a loan to build your swimming pool. You didn't say whether the bank loan was a home equity line or loan. If you're tapping into your home's equity and are able to use the mortgage interest deduction, it's like lowering the loan's interest rate. But you're still likely to be north of 5%.
I'm not a big fan of using 401(k) plan loans to finance discretionary spending, especially if you have to stop contributing to the plan while you pay off the loan and if you lose any money your company would have contributed as a matching contribution to the plan while the loan is outstanding. Check with your 401(k) plan administrator about what, if any, changes take place in the plan contributions while a loan is outstanding.
If you have sufficient liquidity to maintain an emergency fund of three to six months' worth of living expenses and still pay the $20,000 out of savings, I'd suggest that option for financing your swimming pool, presuming you're earning next to nothing in your savings account.
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