Devil's advocate: Borrowing from your 401k
There are lots of reasons why you shouldn't do this, but let's consider the other side of the argument.
One of the oft-discussed cardinal sins in personal finance is to borrow from your 401k, 403b, or other eligible retirement accounts. The reasons against borrowing are obvious: Those assets are for you to consume in retirement, not right now. If you borrow those funds, they can't grow with the market tax-free and you lose one of the great vehicles for retirement planning.
Not everyone can borrow from their 401k or 403b -- the plan administrator has to permit it -- but this Devil's Advocate post will discuss reasons why it may make sense for some employees. Post continues after video.
You have a weak credit score. The No. 1 reason why it would be a good idea to consider borrowing from your 401k is if you have a weak credit score. With loan standards at their highest in recent memory, borrowers with less than good credit may find themselves unable to secure a loan in the first place. If you're buying a house or a car, lenders may require you to come up with a much larger down payment and you could bridge that gap with a loan from your 401k.
When you request a loan from your 401k, there is no credit check, and a credit check can weaken your score even more.
Better interest rates. By borrowing from your 401k, you can guarantee yourself a loan and an interest rate that beats whatever you'd get out in the market. You can call your plan administrator and find out what the prevailing interest rate is and compare it with quotes you get elsewhere to know for sure.
In general, the interest rate will be the prime rate plus 1%. The current Wall Street Journal prime rate is 3.25%, so your standard 401k loan interest rate would be 4.25%. You can't get a 30-year fixed-rate loan for 4.25% right now even if you have a stellar credit score and put down 20%.
Regimented repayment. When you borrow from your 401k, you'll need to repay the loan over the course of five years (longer if it's for a home) and those payments are automatically deducted from your paycheck. There isn't another bill to pay and there's no way for you to "forget" to mail it in.
Lastly, borrowing from yourself is more convenient. There are no long application forms and no fears of rejection. You pay yourself interest, which is tax-sheltered until you start taking reimbursements in retirement.
Many pundits make this issue seem like the worst of the worst in money ideas, but in reality it's not as tragic as they make it out to be.
There's no question that borrowing from your 401k is not ideal. The opportunity costs are enormous. However, many families are going through very difficult financial times and this may be a viable option for them. A fat retirement account is meaningless when you've been out of work for months and you have mouths to feed.
Would you ever borrow from your 401k or 403b? Have you done so already? Any lessons or warnings?
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