In the current economic downturn, many people are stretching their money to the breaking point. There is a general impression that personal, home, and auto loans are more difficult to obtain. In this situation it may be tempting to borrow from a 401(k) plan to make ends meet, but is this a good idea?
- Your plan may allow you to use the loan proceeds for anything, so it can help cover unexpected costs.
- When you borrow from a 401(k) plan, you are essentially borrowing from yourself, so the interest you pay on the loan gets deposited into your account.
- Loan defaults are not reported to credit agencies and won’t affect your credit rating.
- The loan term is limited to five years, unless the loan is for the purchase of a home. This means the payments could be high.
- The amount of money you can borrow from a 401(k) is limited to not more than $50,000.
- If you leave your place of employment, you will have to pay the balance of the loan back within 60-90 days. If this is not possible, the government will consider the loan to be income – and you’ll pay a hefty penalty.
- Loan payments are generally deducted from your paycheck, reducing your take-home pay.
- While the money you borrowed is not in your 401(k) account, you won’t earn any interest on it and you may lose out on future market gains.
So, is it a good idea? Right now, it may not be. Employers are laying off staff in the thousands, so if your employer lays you off, you could be stuck paying back the loan quickly when you’ve also lost your income. And with such volatility in the markets right now, taking the loan now means you may incur a significant loss, or miss out on big gains in the future. Plus, due to the minimum and maximum loan limits, you may not even be able to borrow the right size loan for your needs.