Are you considering taking out a loan against your 401(k)? Your company’s retirement administrator has already given you the green light and reviewed the terms with you. But you’re still hesitant about how it could impact you in the future. On one hand, taking out the loan will give you much needed financial relief, but you’ve also heard that doing so could be risky. What should you do? Read on for factors to consider before taking out a loan against your 401(k).
The Case For Borrowing From Your 401(k)
1. Extended Repayment Term
Did you search for funding elsewhere and were only offered a one or two year term? This may not be beneficial to you if the monthly payments are sky high. However, 401(k) loans are accompanied by a five-year repayment period, so you’ll have more time to pay back the loan. Plus, you won’t run the risk of ruining your credit if you realize you’re in over your head and can’t afford the monthly payments.
2. No Credit Check
If you’re dealing with a serious financial emergency, chances are you need to resolve the issue right away. But if you have minimal or less than perfect credit, getting approved for a personal loan could be a bit challenging. Or you may find that the loans you do qualify for have ridiculous interest rates. However, borrowing from your 401(k) affords you the opportunity to access the cash you need without a credit check.
3. Rapid Funding Time
Beyond the credit check, most lenders require you to complete a fairly extensive loan application to even be considered for funding. And in some instances, you’ll have to submit a host of income documentation to be reviewed by the underwriter, which could take some time. But you can bypass this step by taking out a 401(k) loan because you are borrowing against your own money.
The Case Against Borrowing From Your 401(k)
1. Penalties for Premature Distribution
In the event your employment is terminated, the loan turns into a premature distribution, which means you’ll be assessed a 10 percent penalty by Uncle Sam. The outstanding loan proceeds will also be subject to federal income taxation. This is also the case if you leave your employer voluntarily and can’t repay the loan in full right away.
2. Reduced Take-Home Pay
If money’s already tight, a 401(k) loan could make matters worse. Since the loan payments are automatically deducted from your earnings, take home pay will be lower. And this could make your financial situation worse if you’re forced to borrow even more money to make ends meet.
3. Forfeiture of Earnings
Borrowing from your 401(k) not only reduces your nest egg, but prevents you from letting the power of compounding interest work in your favor. And the more time that lapses, the greater the amount of future earnings you run the risk of forfeiting.
The Bottom Line
Deciding whether to borrow against your 401(k) will depend on your unique financial situation. But if you decide to take out a loan, be sure that it’s only for the short-term to avoid depleting your nest egg.
Written By: Allison Martin
Writer For: Easy.Credit