Is a 401k loan a good idea?
Taking a 401(k) can be a quick and low-cost way to borrow money. Find out when a 401(k) is a good idea, and situations when it makes sense to tap into your retirement savings.
Borrowing from your 401(k) could be the financial lifeline you need to get out of a high-interest debt or when you have an emergency financial need. As long as you have an adequate 401(k) balance and the employer allows 401(k) loans, you can get approved quickly. Since you are borrowing from yourself, you dont go through a lengthy approval process.
A 401(k) loan can be a good idea when you need cash for a short-term liquidity need due to the quick approval and low-interest rate. You can take a 401(k) loan to pay a high-interest debt such as a bank loan or credit card debt to avoid accumulating further obligations. Also, if you are buying your primary residence, you can take a 401(k) loan to pay the down payment or closing costs of the property.
When a 401(k) Loan Might Make Sense
When you need money for a short-term financial need, you could consider borrowing against your retirement savings instead of taking a bank loan. Some of the instances when it makes sense to take a 401(k) loan include:
Pay off high-interest debt
If you are struggling to pay off high-interest debt such as credit card debt, you can take a 401(k) loan to pay off the outstanding loan balance. Usually, a 401(k) loan charges a lower interest rate than a bank loan or credit card loan, and you can expect to pay one or two points above the prime rate.
For example, if your 401(k) loan has an interest rate of 4%, and the credit card loan has an interest of 15%, it would make sense to use a 401(k) loan to pay off the unpaid credit card loan and save money that would otherwise go into paying loan interest.
Make down payment on a home
A 401(k) loan might make sense if you are borrowing to pay down payment for your primary residence. The 401(k) loan won't affect your chances of qualifying for a mortgage loan, since it is not technically a debt, and hence it has no impact on your credit score or debt-to-income ratio.
However, if you need a large sum of money to finance the purchase of a residential house, a 401(k) loan may not be a good option. Instead, you should consider taking a mortgage loan, since you will get tax deductions on interest payments; a 401(k) loan does not offer these tax deductions.
You need money for a financial emergency
If you are in a temporary financial need and you need money quickly, you can take a 401(k) loan to pay the expenses. A 401(k) is a good source of short-term funds since it has a lower cost and you can get your money in the shortest time. There are no credit checks involved, and this shortens the loan processing period. If you pay back the short-term loan on schedule, the loan will have a little impact on your retirement savings.
Pros of 401(k) loans
Here are some of the reasons why a 401(k) is a good idea:
Pro: Credit score not required
Since you are borrowing your own money, your credit does not affect your ability to get approved for a 401(k) loan. Also, when you request a 401(k), the plan administrator does not make a hard inquiry, hence the new loan won’t appear on your credit report. If you default or miss a payment, the plan administrator will not report your delinquent payment to credit bureaus.
Pro: Lower interest rate
A 401(k) loan allows you to borrow at a lower interest rate than what you would get with a bank loan. You can expect to pay 1% to 2% above the prime rate. This interest is paid back to your 401(k) account.
Pro: Multiple loans
If you need more money, and you already have an active loan from your 401(k), you may qualify to get a second 401(k) loan. However, the total of both loans should not exceed 50% of your 401(k) balance or $50,000, whichever is lower. If you have exhausted this limit with the first loan, you cannot get a second loan.
Cons of 401(k) loans
Con: Borrowing limits
You can only borrow the lower of half your 401(k) balance or $50,000. If you need to borrow more than the allowed limit, you may be forced to look elsewhere.
Con: Loss of potential gains
When you take a 401(k) loan, you take out money that is invested in various options such as mutual funds and stocks. This means you will miss out on the gains you would have otherwise earned on the money. Unless you pay back the money immediately, it is impossible to recover the lost gains.
Can you borrow from an old 401(k)?
If you have an old 401(k) left with a former employer, Beagle can help you take a 401(k) loan. Beagle not only helps you find your lost 401(k)s, but we also unlock your old 401(k)s so that you can take a 401(k) loan against your retirement savings.