Should you Borrow from your 401k

Like most questions, there should never be a simple, nor single answer.

Any kind of borrowing has to be matched with the nature of the debt being retired. For example, short term debts, like buying a new big screen plasma, should not be paid off from a long term debt account, like a home equity loan. Using such a long term vehicle for sort term purchases will put you into debt very, very quickly, and you’ll have no idea how you got there and very little to show for your debt.

Items that have a relatively short useful life should be paid for through the use of short term loans or overdraft accounts. These are usually unsecured, so they will carry a higher interest rate. Therefore, discretionary cash from savings is always best.

If you’re disciplined enough, short term purchases are precisely what credit cards are best for. Short term items that you can easily pay off during the grace period. Otherwise, you may want to evaluate lending cooperatives, such as at At this site, prospective lenders bid to lend you money, at rates that are consistent with your credit history. You may be able to get very good rates here, with an emphasis on three year loan repayments.

401(k) plans present different considerations, however. Most of these loans are for 5 years and should therefore, be matched with short term or extraordinary needs.

The plan’s description usually makes a loan sound risk free, but there can be significant downside risk, including real losses and opportunity losses. These can add up. Additionally, there are no tax benefits, and potentially can offer tax liabilities, instead.

When you borrow from your 401(k), you have to sell a corresponding amount of stock or mutual fund, to raise that money. From that moment on, until your loan is paid off, you will lose any chance to gain from any price appreciation that your securities might have had. Tax free appreciation, no less. This is lost opportunity. Imagine 5 years of lost profits and on top of that 8, 9 or 10% interest.

Even though you are borrowing from yourself, there is no such thing as a free lunch. This is a fully secured loan, but you will pay for the right to borrow from yourself. Make no mistake, there is profit to be made at your expense, and that profit can be steep. Imagine paying 9% to use your own money !

Additionally, you must be very disciplined, in that you have to be certain that you can pay back this loan according to very strict terms. If you are late on a payment, you will go into default. Although this will not be reported on your credit files, the result is far worse. Once in default, not only will you have to pay taxes on the default amount, but you will also have to pay a 10% penalty!

However, there are times when the need for short term cash is extreme and unavoidable. In cases like that, the 401(k) may be an acceptable option, as long as you fully understand the consequences of not being in compliance with loan provisions.

If you do borrow from your 401(k) do not think of it as your own money. Consider it to be like any other kind of debt. One that has to be taken seriously.