Using a 401(k) Loan to Escape PMI Costs


Dear Dr. Don,

I am considering borrowing money from my 401(k) plan to pay down my mortgage balance and eliminate private mortgage insurance, or PMI. The loan from my 401(k) would have no fees with a 3.25% interest rate. I would have to pay it back within five years of the original loan date. (But I would try to pay it back even faster.) What do you think is the better option?

I estimate that I would save approximately $5,100 in PMI payments by doing this. I don't qualify to use the PMI as a tax deduction each year due to income constraints. The loan would be about $13,000. I cannot determine which option is better.

Thank you,

-Needs Advice

Dear Needs,

One argument against taking the 401(k) plan loan to pay down your mortgage balance and get the PMI canceled would be that you would lose your employer's matching contributions, having reduced 401(k) contributions to make the loan payments.

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Under your plan, you would borrow $13,000 to save $5,100 in PMI premiums. You would gain the benefit of reducing your outstanding mortgage balance, lower the interest expense on that mortgage and pay off your mortgage sooner.

Your plan loan at 3.25% would probably be lower than the rate of interest on your mortgage. But interest on the plan loan is not tax deductible.

Before you talk to your 401(k) plan administrator about the plan loan, talk to your mortgage servicer to confirm that you would be able to force cancellation of the PMI policy. You won't want to go to all of this effort if you aren't going to achieve the desired benefit. You have some more work to do to learn the actual answer.

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