I don't understand that last formula Beltim. Can you explain the cost/benefit formula:
loan balance * (401k interest rate) * (effective aftertax interest rate of mortgage)
Doesn't make sense to me, but I would love to understand why you calculated it this way. Honestly.
Yeah, I'll give it a shot. This is my attempt at calculating the cost of using funds to repay the 401k loan instead of using those funds to pay back the mortgage (in the absence of a 401k loan). It's what I thought you were suggesting as an alternative use of funds, but I could easily be mistaken. As to the math, [loan balance * (401 interest rate)] just give the amount of money that has to be paid back from other funds this year. The benefit of using that money would be the amount multiplied by the effective after-tax interest rate on the mortgage (you used 3.46% assuming it's all tax-deductible, but it could be as high as the interest rate itself depending on other deductions).
That make sense?
Not sure. Here's what I would do. Like you, first figure up the Present net cost or benefit. Then determine profit.
Benefit is getting rid of the effective mortgage interest rate.
Present Benefit = $100k*.0346 = $3,460
The present cost would be the taxes paid on the 401k interest (a cost the OP previously avoided due to the tax deductibility of mortgage).
Present Cost = $100k*(.04125*.25) = $1,031.25
net benefit = $3,460-1,031 = $2,429 Net Benefit
profit = benefit - opportunity cost - PV of future tax liability on the 401k interest.
2,429 - (100k*.02) = $429
Finally, you'd need to subtract the PV of the future tax liability on the $4k interest that will be paid back into the 401k. Let's assume his future tax rate will be 15%. So, that's $600 owed ($4k*.15) in, say 20 years. The present value of $600 owed in 20 yrs, assuming a 2% ror = $404. (the formula is complicated, but you can use a financial calculator. FV=600, PMT=0, i=2, n=20, solve for PV)
$429-404 = $25
So, given these assumptions the OP would by my calcs come out $25 ahead. Assuming the loan fee is probably at least that amount he'd probably break even.
The assumptions I used were:
Loan amount: 100k
Mortgage rate: 4.6125%
401k Int Rate: 4.125%
Stable Value Return: 2%
Current Tax Rate: 25%
Retirement Tax Rate: 15%
Years to Retirement: 20
Obviously modifying any of these assumptions will affect the outcome. But the methodology, IMO, seems sound. Any issues with this? Am I missing something? I have a degree in Finance, love numbers, and solve equations in my free time. That doesn't mean I'm not dead wrong sometimes - I am. But the methodology above seems clearly to be the best way to solve this problem.