Borrowing
from Your 401(k) Plan To Purchase a Home
Of the
many options you have when you need to borrow money to make
a major purchase, borrowing against your 401(k) is one of
the more tempting as it can be a relatively simple process.
It is actually a fairly common practice, especially when used
for the down payment on a house.
Usually
you can borrow up to $50,000 or 50% of your 401(k) balance,
whichever is smaller. But it it is not without some potential
consequences and shouldn't be a decision made lightly, especially
when you need a quick and cheap loan.
Here are
the pros and cons of borrowing against your 401(k):
Pros
- You
can get the loan quickly, usually within a week or so of
applying to your company.
- You
don't have to qualify for the loan through a credit approval
process because you're borrowing your own money.
- The
interest rate is quite low, usually at prime rate or slightly
over prime, so it is relatively low given todays interest
rates.
- The
interest that you do pay is actually paid back to you and
your account.
You generally have 5 years to pay it back and usually 10
years if you use it for the down payment on a house.
Cons
- You
are slowing down the growth of your retirement fund. The
money you withdraw stops growing until you pay it back,
which can have major implications down the road.. Some plans
don't allow you to make more contributions if you have an
outstanding loan, which hurts your retirement savings even
more.
- You
repay the loan through payroll deduction, so the loan will
cut down your take-home pay.
- If
you leave your job either voluntarily or involuntarily,
you have to repay the entire outstanding balance in 60 days
or face a huge tax bill. This can be very difficult to do
when you are leaving your job, particularly if you are laid
off. If you don't pay it back, the remaining balance is
hit with a 10% early withdrawal penalty and you have to
pay federal and state income taxes on it that year. So if
you had borrowed $50,000 and couldn't pay it back, you would
have to pay a $5,000 penalty and federal and state taxes
that could take another $20,000 of the amount.
Reality
Borrowing against your 401(k) can make sense as last resort
if you need to make a major purchase like a house down payment
that you can't come up with from anywhere else. But consider
this step very carefully before you take it.
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