Stumped About Loans
February 24, 2018 12:45 AM   Subscribe

Explain this loan situation to me as though I know nothing about loans (because I know nothing about loans).

It’s been a crazy year. I’m getting married in a few months. When we got engaged I told my fiancée that spending $20,000 on a wedding while we were dependent upon in a car that was drinking age with 280,000 miles on it seemed like a not great idea, but after two days of silent treatment I decided to reconsider my position and take a gamble on the car serving until after the wedding is behind us. This morning that gamble turned out to be exactly as risky as I thought it was; our car is mostly dead and the cost of repairing it would be more than the car is worth. That, combined with an unexpected bout of pancreatitis that left me hospitalized for three days a few months back means that I need some money to the tune of about $10,000.

Here’s the tricky part: I know nothing about loans. A childhood spent watching my parents struggle to get out from under the debt that they’d accrued as a result of my father getting cancer and then no longer being employable in the field that had previously supported him left me averse to the thought of accruing even minor debt. My credit score is an unimpressive 612; not astonishingly terrible, but not confidence-inspiring either. It’s not that I’ve been bad at paying off what I’ve owed; it’s that I’ve never owed much of anything to anyone because I couldn’t be bothered to purchase anything that I couldn’t pay for immediately. I’m a credit non-entity, basically.

I have a very healthy 401(k) that I could take the loan from. I’ve also been banking with no problems with the same bank for the past decade. I’ve been working at the same job for twelve years now and I earn just shy of $70,000 a year; I am not at all worried about my ability to pay back this loan.

What I’m wondering is if I should approach my bank about a possible loan or if I should just take the loan against my 401(k). I’d like to start building my credit but at the same time I don’t want to end up paying a lot more than I need to.

Just to get this out of the way: Financial help from either my family or my fiancée’s family is out of the question. Both of us are doing better financially than our parents at this point. My fiancée has a much better credit score than I do, but that comes from making regular payments on her mountain of student loans; she is not looking to incur any further debt at this time.
posted by anonymous to Work & Money (25 answers total) 2 users marked this as a favorite
Don't take a loan from your 401K. Not only will you have to pay taxes on it, but you'll also pay a 10% early withdrawal penalty. I just ran the numbers on a $10k auto loan, $1500 down, at 4% for three years, and it's about $450 less than that withdrawal penalty, not even considering what you'd earn from interest over the next couple decades. (A lot.) Plus, pulling from your 401k does nothing to build your credit, and screws over future you.

So, time to talk loans. First, the hospital. It's exceedingly unlikely that they're going to require you to come up with the full value you owe them. Call them, and ask if there's a discount for cash payments. Some hospitals will cut your bill substantially if you don't have insurance. Regardless of what they say--if they reduce the money owed or not--tell them you can't afford to pay the bill in full, and ask to set up a payment plan. My experience is that hospitals are almost always happy to set up a payment plan, often with no or minimal interest, and often with very low payments. Let them set you up on this plan, and then make the payments.

Second, the car. Are you a member of your local credit union? If not, now's a great time to join one, because credit unions are fantastic for this sort of thing. I bought a car as a credit nonentity a couple years back, and the credit union gave me a great rate. If you're not a member of a credit union and can't become one, you're going to want to go for a bank, but my advice is credit union first. Go in, tell them that you'd like to talk about a car loan. They'll ask you how much you think you'll need and what you'll be putting down, and they'll run some numbers. They're going to want to see your driver's license and probably social security card, as well as a couple of recent paystub. (Or, at least, that's what my bank wanted.)

They (hopefully) approve your loan, and tell you that they can loan you up to [amount]. Sometimes they'll give you a blank check at this point. It says 'not to exceed [loan limit]', and you can fill it out as needed at the dealership. You go to the dealership, look at some cars, decide what you want, and fight about the price. Once you've agreed on a price, the dealership will try to get you to finance with them--if they can offer you better terms than your credit union can (unlikely), there's no harm in switching your financing at that point.

If they didn't give you a check, you'll get the dealership to draw you up a purchase agreement, and then you take that to the bank. The bank gives you a cashier's check for the amount, which you then take to the dealership, and you drive away in your new car. All of this is slightly time-consuming, but not especially difficult, and it's a much better plan than taking money from your 401K.
posted by mishafletch at 1:44 AM on February 24, 2018 [11 favorites]

Approaching the bank is definitely an option. Your employment history and history with them is probably more important than your credit score. In your situation, it is very likely to be fairly easy to get that loan. It is not a bad idea to check with a credit union for the reasons listed above, all of which seems like sound advice.

It's quite easy to be stumped about loans and credit if you've been avoiding them. Some people avoid the world of credit, because it is related to owing money, and it seems like you may fall into that trap. Being in debt can be bad for all the reasons you learned as a child. However, avoiding credit and loans does not prevent such a situation from happening. If you were to get ill and accrue a hundred thousand dollars in medical debt, your 612 credit score will not prevent them from continuing to add on to that debt.

So, if refusing to play the loan and credit score game doesn't actually prevent such a situation, you're mostly hurting yourself when it comes time to take advantage of the possibility of a loan.

Debt is not necessarily a bad thing. It's a bad thing if you cannot repay it, but if you have a steady job and have enough left over each month that you could pay off a loan, you have the ability to repay it. If you have a 401(k) that you could take the money from in a crisis, you have the ability to repay it. It seems like you have at least two viable repayment strategies, so repaying it does not appear to be a problem.

Interest rates on long-term loans such as mortgages and car loans tends to be lower than the rate of return on investments, so taking a loan means that you continue to grow your investments at a rate greater than the loan is costing you. If you take out a 5% APR $20000 car loan over 5 years, that loan will cost $22645 (60 payments of $378). Over that same time, leaving that $20000 in your 401(k), if it is earning a tepid 7%, it grows to over $28000. That's more than $5000 extra by keeping the money in your 401(k) and taking out a loan that you know you can repay.

Long term, you may want to look at strategies to improve your credit score. Improving your credit score is mainly tied to reports of your good use of credit. This information may come from various sources, including timely payment of bills, etc. With a higher credit score comes the option to tap into better credit deals. This is basically a big game played by the financial industry. You can refuse to play it (more or less what you've been doing) or you can play their game and even profit from it. By having a high credit score, and by running most expenses through credit cards, I qualify for cards where I get a variety of deals ranging from cash back (between 2 and 6%), extended warranties on purchased items, the ability to get post-sale price adjustments (Citi Price Rewind), etc. You don't get any of this if you don't play their game. You need to set some rules for yourself to do this, but in the end if you play this game, you can easily end up with a credit score in the 800's, at which point taking out a car loan is very easy.

Getting started can be difficult, but playing the credit game is something best done before you have a need for credit. Once you're past your current issues, seriously look into how to start moving up in the credit world. Take care to make sure you're keeping up with everything. Open a new credit card every year or two and make occasional charges on it, paying it off right away. You'll find it easier next time.
posted by jgreco at 3:24 AM on February 24, 2018 [1 favorite]

I don’t know whether you should take out a 401k loan (although that’s how I usually buy cars) but I do know that you do not pay a penalty for taking one. That’s only for hardship withdrawals.
posted by ftm at 4:31 AM on February 24, 2018 [13 favorites]

Hang on, you're spending $20,000 on a wedding? That is plain crazy. And when you expressed doubts, your fiancee gave you the silent treatment and you caved?

Stop right there. This is not someone you should be marrying at all. Coercion and insane, avoidable debt? That is not a future you want.

posted by Grunyon at 4:32 AM on February 24, 2018 [63 favorites]

Get a car with a loan, don’t do an unsecured personal loan or borrow from your 401k ( which would be a better deal than an unsecured personal loan with your credit rating)

The marriage is a different discussion, but the car issue is pretty straightforward.
posted by JPD at 5:00 AM on February 24, 2018 [1 favorite]

Don't take a loan from your 401K. Not only will you have to pay taxes on it, but you'll also pay a 10% early withdrawal penalty.

This is not correct. As long as the 401(k) loan is paid back, there is no penalty or taxes paid on it.

Approaching the bank is definitely an option. Your employment history and history with them is probably more important than your credit score.

Also incorrect. Banking for the most part is driven by the math of the credit score. Loan officers have some wiggle room, but ultimately whether you get a loan and the interest rate will depend on your credit score, not history with the bank. You can get a ballpark quote from them based on your estimated credit score but I suspect it will not be very good, particularly for an unsecured loan.

My fiancée has a much better credit score than I do, but that comes from making regular payments on her mountain of student loans; she is not looking to incur any further debt at this time.

The following statement is not strictly true but it's how both of you should be thinking - if you're getting married, her debt is your debt and your debt is her debt. If you're entwining your futures and she's expecting an expensive wedding but not willing to leverage her better credit score to keep your (plural, as in ya'll) financial future solid, you have a few problems.

Your best bet for the medical costs is probably the 401(k) loan (and reducing some of the wedding costs if you're not already constrained by signed contracts). One change from last year's tax bill is that they are now a lot less risky - if you lose your job or leave it, you'll have at least a year to pay it back (as opposed to a month or two previously). Many of the sites you'll find on the internet telling you that you shouldn't take a 401(k) loan have not been updated since this change. Also, any site that tells you that you shouldn't take a 401(k) loan specifically because you'll be double taxed is making an invalid argument. Any loan you pay back will come from post-tax money, it's just the nature of things. Whether you're paying that money to yourself or a bank is immaterial.

The interest on it gets paid to you, so the only nominal cost is what the setup fee that your provider charges. You'll also have an opportunity cost in that you'll lose out on the performance of that money in the retirement fund. If you get lucky, the stock market will go down this year (it probably won't, at least not until the election) and you'll actually come out ahead. But if it goes up 20%, you'll effectively pay 20% interest on the loan. With your credit score, that probably still beats an unsecured personal loan. Again, get estimates from conventional loans to compare against.

The car loan may or may not be better getting a secured car loan from a bank or also including it in the same 401(k) loan.

Moving forward:

1. Build up a healthy emergency fund. This sort of thing shouldn't swamp you, especially when you know that the cost of replacing the car is looming. If you have a healthy 401(k) but can't handle these costs, you may be putting too much aside for retirement.
2. Make sure this is the right person and time to get married. Grunyon is correct that someone acting petulant about spending one third of the median household income in a day when you don't have a lot of money is a warning sign, as is my comment that she apparently thinks of her credit score as hers when she's driving you into debt.
3. Get your own credit score rehabilitated. There's lots of guides on the internet on how to do this. Do not pay money for it - mostly it comes down to making sure everything's paid on time and using a small amount of credit responsibly.
posted by Candleman at 5:06 AM on February 24, 2018 [12 favorites]

Of corse approach your bank - there's no downside to just seeing what they can offer. While you're at it talk to your 401(k) administrator about what it would look like to take a loan against your 401(k). Once you have both terms for both, sit down and look.

Give some thought to whether you want to marry someone whose values - at least with regard to money - clash with your own. Particularly if you're not able to talk through those differences together and come to mutually agreeable solutions.
posted by bunderful at 5:18 AM on February 24, 2018 [6 favorites]

Leaving aside the part where you are are spending $20K you didn't want to spend on a wedding to a person who blackmailed you to do that with the silent treatment and isn't willing to take on more debt to help the pair of you pay for this wedding, a necessary car, and debt from you being in the hospital...

First of all, never take on debt to pay medical bills, which are the most negotiable bills you can have. Medical bills are basically already long-term loans; all you're doing is negotiating the repayment terms.

Second, walk into your bank branch and find out what they can offer you for a car loan. Then compare the rate to the bank next door. Do NOT do dealer financing, but maybe look at leasing if you want to be able to predict payments and repair costs exactly for tighter financial management while you are facing several large expenditures.
posted by DarlingBri at 5:33 AM on February 24, 2018 [2 favorites]

I once took a loan from my retirement plan. It was secured by my retirement funds, but I was not withdrawing the funds, so no tax issues or penalty as long as I paid it back. It was deducted from my pay and easy. Interest rate was competitive, and I was paying myself. As long as you don't incur the tax or the 10% penalty, this may be the best deal for the car.

The bank will have car loans available. Even at my credit union, the rates on car loans aren't favorable. Check the rate. Paying off medical debt may require a personal loan, also not at a favorable rate. Going forward, consider a credit union; they can be a lot easier to work with on loans.

You don't mention getting a loan from a car dealer. Generally the worst idea. Even loans that look great may have hidden costs. Buying a car is a whole other Ask.Me, and there have been some worth googling.

If a lot of the medical debt is through a hospital, they almost certainly will have a payment plan. Talk to them 1st, as it could be a decent interest rate. Listen to DarlingBri.
posted by theora55 at 6:04 AM on February 24, 2018

I incurred an absurd amount of medical debt over the last few years. It is more than a car worth. I'm paying it off at the princely sum of $150/month, no interest. Call the hospital and negotiate a payment plan.

As to the car, talk to your bank, a credit union or two, and see what the dealer can offer. I'm pretty sure you can get a loan no problem, and would not borrow against the 401k for the reasons others have outlined.
posted by notjustthefish at 6:31 AM on February 24, 2018 [1 favorite]

The issue with a 401(k) loan is that if you lose your job, the balance will come due in full immediately. For a small cash-flow issue it can be fine, but for a car-size loan, you’re gambling in your continued employment; if you had the liquidity to take that gamble, you should spend it on a car instead.
posted by chesty_a_arthur at 6:34 AM on February 24, 2018

The issue with a 401(k) loan is that if you lose your job, the balance will come due in full immediately.

Again, this just changed and is no longer true.
posted by Candleman at 6:45 AM on February 24, 2018 [1 favorite]

Really? It was true in September.
posted by chesty_a_arthur at 6:55 AM on February 24, 2018

Your fiancee's attitude about wedding expenses is alarming. Finances can be one of the strongest stressors in a marriage and her inability to have an adult discussion about them is a huge red flag. During your marriage, another financial disagreement will almost definitely come up, so this isn't going to be a one off scenario that you can capitulate on now for the sake of harmony and put behind you. You might be signing up for a long time dealing with joint consequences of unilaterally made financial decisions.
posted by Larry David Syndrome at 6:58 AM on February 24, 2018 [16 favorites]

I'm not touching the rest of this, but dude, you make nearly $70k a year, just walk into a car dealership and buy a car. Why are you thinking about touching your 401k? They make loans for cars. You can optimize that process if you want to, but if you don't have the time/energy to mess with it? Just go buy a car. They will hold your hand through the whole financing thing if you do it through the dealership, which is not to say you have to, but if you don't have the energy to deal with all the rigamarole, just go buy the car. It is way, way less painful than you're making this. You don't need great credit to get a car loan; barely-mediocre credit is plenty.
posted by Sequence at 8:31 AM on February 24, 2018 [6 favorites]

Consider your monthly budget and think about what kind of payment you can accommodate. That will drive your car budget, but you can definitely go to Carmax or somewhere and finance a good used car. Lower credit score will increase your interest rate, but that's just baked in to the payment, and I assure you it will be cheaper than an unsecured personal loan and a sub-$10K beater.

If you want to, you can talk to your bank about an auto loan, give them some idea of what you're looking to buy, and see what they'll pre-approve you for. That way you can go into the dealership with a sight draft in your pocket and just choose the best deal. It doesn't become an official loan until you buy the car and set the exact amount.

Then talk to the medical provider about a payment plan. Next resort would be a 401k loan, but probably unnecessary.

How are you paying for the wedding? $20K in money that you already have? If so, you seem like the sort of responsible person that will be able to handle this.
posted by Huffy Puffy at 8:40 AM on February 24, 2018

When you go to the bank/car dealership and fill out the loan paperwork, they will want to know what assets you have, how much money you make, and what other loans/rent/etc. you have, so they can tell what your budget is like.

So, to re-emphasize: If you have most of the $20K in the bank now, or in instruments that are available to you, you should go buy the car now, while that money is still on your balance sheet. That should dramatically lower your credit risk. They don't need to know that you have other plans for that money later; you have it now, and in an emergency you could use it to pay for the car. You're still going to borrow money to buy the car, but the point is that it will look like you don't need to.
posted by Huffy Puffy at 8:49 AM on February 24, 2018

As others have said, you should be able to get terms yourself from both your bank and your 401(k) administrator and compare them (including any setup fees for the 401(k) loan). This shouldn't cost you anything. The 401(k) loan job loss situation has changed this year, though I think not quite as described above. Basically you have until April of the year following your job loss to repay the loan: so, as little as four months, or as much as sixteen, depending on when it happens. So it is less risky, though not risk-free. What might be considered undesirable about taking a 401(k) loan is what it does to your mindset. You should really be thinking of that money as just unavailable to you, not something you can factor into your planning. While the expenses you're considering paying with them aren't trivial or avoidable, the fact that you can't pay them, or a good chunk of them, wasn't inevitable. You spent 28% of your gross income on a wedding, despite your serious misgivings. You're marrying someone who thinks it's her job to decide what you spend but not to contribute to it. I'm not saying this to criticize, but you do not want to get into the habit of thinking of this as money you or your fiancee can tap, because it will cost you. You want to maintain that mental barrier. Mindset is important in staying out of debt, though hardly all-powerful. So if the difference in cost between bank loan and 401(k) loan isn't large, you might want to opt for the former just to maintain the barrier. But not if the cost would be significant.

If you want to further build your credit, open a card (in your own name and not jointly with your fiancee, sorry) with no annual fee and a low interest rate (though technically this shouldn't matter, as you're not going to pay any interest). Pick one set of routine, relatively modest, recurring expenses to put on it--cable bill and phone? Pay those off in full by the due date every month. Don't put anything else on it. Just having a card with low utilization and a history of regular payments will steadily improve your score over time. Don't play the "credit card game." It requires a certain mindset and approach to life which just reading your post I can tell you don't have, and it's way too easy to blow your fingers off if you get careless or unlucky.

I'm not sure whether $10K is your total expenses or what is left after you already covered a larger sum with your existing emergency fund. If the former, if you have a healthy 401(k) but can't handle $10K in emergency expenses without a loan for most or all of it, you are putting too much into your 401(k) right now. (That's less than 2 mos. income.) If you are allowing yourself to be pushed into spending your emergency fund on a wedding, it is not an emergency fund! Please reconceptualize. It's unlikely that this will be the last time something like this happens.
posted by praemunire at 9:23 AM on February 24, 2018

When you go to the bank/car dealership and fill out the loan paperwork, they will want to know what assets you have, how much money you make, and what other loans/rent/etc. you have, so they can tell what your budget is like.

For whatever it's worth, this was not the case with my recent dealership car loan. They ran a credit check, verified my income, and asked how much I wanted to put down. They never asked for or received my bank account balances.
posted by Sequence at 10:06 AM on February 24, 2018 [2 favorites]

Marriage and Money.
You have no debt until now. Your fiancee has a pile of student debt. You both have parents with little experience of managing money successfully. You both need to learn more about money. And you need to work out how you will manage money in your marriage. Money pressures can really put stress on a marriage. Personal Finance Blogs - Find a couple you like, read weekly.

Are you paying for the wedding as you go? That makes it sound like it's a stretch but manageable. But money decisions keep coming up. You need a car. Honestly, I'd spend @ 10K and get a pretty good used car, even if it involves some debt. You knew the car was going to die, but you didn't listen to your common sense. So use your sense to make this next financial decision. Can you and Fiancee be a team and make a good decision together?

The guy I married had student debt. Unfortunately, he's also a deadbeat and moocher. We did a smart thing that saved me from a lot worse financial pain. We met with a lawyer to talk about how money works in marriage. List your debts and assets. That's all pre-marital stuff. In some states, her pre-marital debt will stay hers. Talk about your goals and set financial goals together. Talk about how you will make financial decisions. Whether you will provide support to parents, what kind of house you might but some day. Read some books about personal finance. Andrew Tobias is my favorite, but there are many new books.

John Gottman, PhD, has done a lot of research on what makes marriages work, and things that sabotage marriages. Recommended. Best Wishes.
posted by theora55 at 11:24 AM on February 24, 2018 [2 favorites]

Forbes article on the 401(k) loan change.

Dallas News article on it.

Per the articles, the new deadline is mid-October of the year after leaving the job, giving roughly 10-21 months to pay it back.
posted by Candleman at 12:41 PM on February 24, 2018 [2 favorites]

Per the articles, the new deadline is mid-October of the year after leaving the job, giving roughly 10-21 months to pay it back.

I admit I'm too damn lazy to look up the language of the law itself, but what the Dallas article doesn't explain (I am not turning off my adblocker for a content mill like the current Forbes website) is that the offset rollover deadline is the filing due date. So October isn't quite right. October is assuming that you will request an extension on your tax-filing (which would require that you pay all the rest of your tax liability for the prior year before filing or else get hit with late-payment penalties). Otherwise, it's going to be April. (And if you get to October and still haven't managed to pay, it's not entirely clear to me whether you get hit with late-paying penalties on that amount dating back to April as well as any other tax liability, which would really be the cherry on top.) Being brutally practical about people's capabilities, which I think you need to be when talking personal finance, I would not want to rely on someone who's managed their affairs badly enough or been unlucky enough to need a 401(k) loan and lost their job in relatively short order to be together enough to thread that needle.

But, definitely, either way, it's less risky than it was. A rare somewhat reasonable feature of the new tax law.
posted by praemunire at 2:02 PM on February 24, 2018

In my experience car loans have by far the lowest interest rates, even for a used car. I’m not touching the wedding issue either, but if you could find a $10,000 used car at a 2.3-4% interest rate for say, five years that would be ideal. You can always pay more monthly once you’ve gotten through the medical and wedding bills. I paid off the last of a $12,000 car loan last week after 5.5 years and in looking through the statements discovered that I only paid $89 in interest for all of last year.

I would say don’t dig into your retirement money or stocks unless you’re positive you can pay them back. But I say this as someone who had to clean out all my meager retirement money and savings and stocks in the last couple years. I’m down to $0 in the bank and had a huge tax bill in 2016 that I’m still paying down and very close to 50 so YMMV.

I found What’s the Cost to be very valuable lately. It lets you enter multiple loans and minimum payments for each of them. Then it gives you a detailed payment plan based on your choice of “pay by balance” or “pay by interest.” In my case I set a minimum debt payment amount per month and am devoting most of that amount to my high interest credit card now. Once that’s paid off I’ll throw that same amount at my 0% interest debt and will pay it off relatively quickly.

I think the best way to get familiar with how loans work is to run some actual numbers through one of the many financial calculators on the web and think about a steady monthly amount that you budget for debt. (If you don’t already have a budget, making one would be an excellent place to start - again there are good calculators online or in phone apps that you can use.)

I tend to be obsessive about my monthly spreadsheets and enjoy organizing bill payments by paycheck and watching the amount I still have to pay decrease.

Like most fears, I think this one will have less of an impact the more you’re able to learn about it.
posted by bendy at 5:09 PM on February 24, 2018 [1 favorite]

Spending $20k on a wedding is not crazy. That's about the median wedding cost in the US. However, spending $20k on a wedding when you have to go into debt to do it.... that's crazy.
posted by bq at 2:52 PM on February 26, 2018 [2 favorites]

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