Don't borrow from 401(k) to pay mortgage
Greg Kratz
But then I remember that my 401(k) is supposed to allow me to enjoy a huge TV when I'll actually have time to watch it ... during my retirement.
Those thoughts helped me relate, at least somewhat, to this week's letter-writer.
Eileen said she and her husband have two homes. They owe $400,000 on a summer home ($2,400 per month) and $190,000 on their primary residence ($1,700 per month). Those payments, Eileen wrote, "are killing us."
"At the present time we have approximately $625,000 in retirement," she wrote. "I am 47, my husband 49. We plan to work at least another 10 to 12 years. Although we both have good jobs, we are now living paycheck to paycheck. ...
"I don't want to give up our summer home. It took us 20 years to finally purchase it. We didn't buy it for an investment. We bought it to enjoy now and later when we retire. I have been thinking about selling stock and maybe borrowing from (the) 401(k) to pay off the primary residence. I kind of know how you feel about this, but is there a way I could pay off my primary residence to take the huge burden off us?"
Jeff says that, before you decide to borrow from your 401(k), you should consider the pros and cons.
The pros, he says, are that such loans usually require no credit check, offer a "pretty nice" interest rate and are convenient.
But then Jeff went on a self-described "rampage" about the cons.
"First, there isn't a credit check because you aren't really borrowing anything," he says. "You're spending your own money."
Second, taking out a 401(k) loan has opportunity costs. Jeff says government studies show that, in most cases, the interest rate you pay yourself is less than the rate your money would have earned if left in your 401(k).
Next, you'll most likely repay a 401(k) loan out of your salary with after-tax dollars. Since you'll have to pay taxes on your 401(k) funds when you take the money out after you retire, you're setting yourself up for double taxation, Jeff says.
"Fourth, if you take out a loan and then you retire or change employers or get laid off or fired, usually that loan has to be paid back right away, and it's not uncommon for plans to require full repayment within 60 days," he says.
If you can't repay the loan, you may be considered in default, so you'll be taxed on the full balance, Jeff says. And if you're under 59 1/2 years old, you may face another 10 percent penalty.
The fifth problem, he says, is that the interest you're paying on a 401(k) loan is not tax deductible. And sixth is that most people who take out such a loan subsequently reduce contributions to their 401(k) plan because they're trying to pay back the loan.
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