Borrowing Against Your 401K: A Loan from your Future Self
- Written by Candice Elliott
Your 401K is meant to fund your retirement. But you can withdraw money from it earlier. Is borrowing against your 401K ever a good idea?
It goes against personal finance philosophy to take money out of a retirement account before retirement but under the right circumstances, it is something to consider.
Borrowing against your 401K means you are borrowing from yourself. Unlike borrowing from a bank, the interest you pay, you pay to yourself. The amount you borrowed is no longer invested so rather than getting investment gains, your “gain” is the interest you pay back.
You can borrow up to $50,000 if you have a vested balance of at least $100,000 or 50% of the value, whichever is less. A home down payment is a good use of this type of loan. Using it for a bigger down payment reduces the amount of long-term interest you will pay on your mortgage and can help you avoid PMI.
Refinancing credit card debt is another good reason to borrow against your 401K because you’re paying yourself back at a much lower interest rate than you’re paying to a credit card company.
You have five years to pay back a 401k loan, ten if the loan was used to buy a home. The exception to these rules is if you leave or are fired from the job. In some cases, you will be required to repay the loan within 60 days.
Be warned, a 401K loan can have bad consequences. If you can’t pay the loan back, it becomes a penalty withdraw so this is not a decision to make lightly or a loan to take out to pay for something frivolous like a television or vacation.
But under the right conditions, it can be a great decision that can save you money in the long run.
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