How do I calculate loan repayments?

How do I calculate loan repayments?

Participant loan repayments are calculated using standard straight-line amortization: equal payments of principal and interest made on a fixed schedule over the life of the loan. Any standard loan amortization calculator will produce the correct figures once you have your loan amount, interest rate, and term.

The interest rate

The interest rate is fixed at the time the loan is originated. The plan document requires a reasonable rate, and the most common practice is to use the U.S. Prime Rate plus one percent as of the loan start date. Because the rate is tied to Prime at origination, two loans taken at different times may carry different rates.

The interest you pay goes back into your own plan account, not to a lender. This is one of the practical advantages of borrowing from yourself.

Payment frequency

Payments must be made at least quarterly. Monthly payments are also acceptable and are often easier to track. Whatever frequency you choose, it must be documented in the loan agreement and followed consistently. Missing a scheduled payment starts the clock toward default.

How to make payments

Write a check or electronically transfer cash from your personal checking account to the plan trust account. If your plan has Roth and pre-tax sub-accounts, payments must be returned to the same sub-account from which the loan was funded.

Setting up a recurring transfer or automatic payment is strongly recommended. 

A quick example

A $30,000 loan at 8% interest over five years produces a monthly payment of approximately $608. Paid quarterly, that same loan would require payments of roughly $1,826. Either approach satisfies the amortization requirement. The total interest paid over the life of the loan returns to your plan balance.

Early payoff

There is no penalty for paying the loan off ahead of schedule. If you choose to make a lump-sum payoff, document the final payment in the plan records and close out the loan agreement.

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Disclosure

This information is provided for educational purposes only and should not be interpreted as tax, legal, or investment advice. Readers are encouraged to consult a qualified professional who can offer guidance based on their personal situation.

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