Don't Let High Interest Make You Low!

Real Estate Agent with Exit Real Estate Consultants

In these financially difficult times, debt is common in Irmo, SC and across the nation and many people are living beyond what they can afford.  Unfortunately, many of the debts we incur have high interest rates and can choke our funds over time.  If you are looking for a way to get rid of high-interest debt, but have already tapped out many of your money sources, you may want to consider borrowing from your 401k. For an explanation of this process, as well as the pros and cons, take a look at our article today.  Don't let high interest hold you down!

Should You Borrow From Your 401k?

Have you refinanced your home into oblivion? Tapped out every available money resource with a myriad of loans and credit cards? There is one last option: borrowing from your 401(k). If you’ve never heard of this option, it’s because until recently, it just wasn’t done that frequently. But with the market still not fully recovered, and people desiring to cut their high interest debt, more folks are discovering this alternative lending source.



Before you go off half-cocked, it is crucial that you understand the pros and cons. Don’t forget that your 401(k) is your retirement nest egg, and you are putting that nest egg into possible jeopardy. If you’re thinking of borrowing from your 401(k) to buy a luxury automobile or a larger home, stop. Mortgaging your future to live a lifestyle that’s beyond your income, while it’s become the American Way, is a mistake. But if you’re trying to get out from under high-interest debt and plan to use this opportunity to live within your income, it could be your ticket to becoming debt-free.

Here’s how they work: most plans allow you to borrow up to half of your vested balance, but not more than $50,000. You apply to the company that manages your 401(k) plan, but you don’t have to “qualify”—after all, you’re borrowing money from yourself. You sign a promissory note and receive the money within a couple of weeks. The interest rate is usually equal to the prime rate or slightly over, so currently you’d pay 3-4 percent interest. You then have five years to repay the loan, and most of the time, you make payments through payroll deductions.
Now let’s look at the pros and cons of borrowing from your 401(k):



  • A 401(k) loan does not appear on your credit report. They are not reported to Experian, and do not become a part of your credit history.
  • The interest on these loans is some of the lowest out there—right now, 3-4 percent.
  • You’re paying yourself the interest, not some bank.
  • You’ll get your money more quickly than if you were using another means of borrowing.
  • Since it’s a loan, you will not be charged the 10 percent early withdrawal penalties plus income taxes you would have to pay if you withdrew the money.
  • You don’t have to qualify for the loan through the usual long, painful credit approval process, because in effect, you are the lender.
  • No assets or collateral are needed to secure the loan.



  • The biggest con is that you are forfeiting the accrued interest you would earn if your money stayed in the 401(k). Calculated over the long term, it can cost tens (even hundreds) of thousands of dollars in potential gain.
  • Unlike a home equity loan, the interest is not tax deductible.
  • Some plans do not allow contributions to the 401(k) for the period of the loan.
  • If you lose or quit your job, the loan is often due in full in 30-60 days (although some plans are open to renegotiating the terms of the loan. Find out before you sign the papers.)
  • If you default on the loan, it is considered a withdrawal and you will owe a 10 percent penalty plus a hefty tax payment. So if you had borrowed $50,000 and couldn't pay it back, you would have to pay a $5,000 penalty and federal and state taxes that could take another $20,000 of the amount.


To calculate the actual cost of borrowing from either source: for a home equity loan, ignoring upfront costs, the after-tax cost is the interest rate minus your tax savings (interest rate times 1 minus your tax rate).

The cost of borrowing from your 401(k) is what your loan would have earned had you kept the money in the 401(k). Since your 401(k) accumulates tax free, the total return on the fund is a close approximation of the after-tax cost.

  • Let’s say you need to borrow $10,000 and you have $100,000 in your 401(k) earning an average of 10 percent a year. Interest on a home equity loan is 8.5 percent and you are in the 28 percent tax bracket. The after-tax cost of the home equity loan is 8.5x(1 - .28) or 6.12 percent. The 10 percent cost of borrowing from the 401(k) is higher than the 6.12 percent cost of the home equity loan.

If both loans are repaid in full after one year: if you use a home equity loan, you will have $110,000 in your 401(k), you’ve paid the lender $10,850 in interest and you have a tax savings of $238. Your financial wealth will therefore be $110,000 - $10,850 +$238 = $99,388.
If you borrow from the 401(k), you will have only $99,000 in your 401(k) at the end of the year because you haven’t earned the 10 percent on the $10,000 you borrowed. Whatever you pay back to the fund does not affect your wealth. You are thus $388 poorer if you borrow from your 401(k).


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Comments (2)

Deborah Laemmerhirt - REALTOR® Brookfield,Newtown,Roxbury,Bridgewater,Washington,Sherman
Keller Williams Luxury Homes International - Brookfield, CT
Luxury Homes,WaterFront,Equestrian,NewConstruction

Hello Craig,

This post is very informative.  Although I have very few clients that choose to use their 401K on their next home or to consolidate their high interest debt, your information can help them to decide.  Thank you for sharing and I will be sure to consult your article for your well thought out points.

Sep 19, 2013 09:14 AM
Randy Mitchelson,APR
Marketing Advisor & Squeeze Mortgage - Bonita Springs, FL
First Impressions are made at First Click

I also recently wrote a post on this subject so that people can make more informed decisions about what is best for them. Should I Borrow From My 401(k) For Home Down Payment?

Short answer: No. However, everyone has a personal situation that is different so you can never say never. Personal finance gurus like Suzy Orman will preach to absolutely not touch your retirement money to take on more debt, even for helping pay for your child's education.


I tend to agree with this philosophy. Fewer Americans have pension plans to rely upon for retirement income. We tend to be a very short sighted culture, not thinking about what our life will be like in 20, 30, 40, 50 years. The more you save at a young age, the more financially secure you are likely to be when you retire.

However, I want you to understand the facts so that you can make an informed decision and not just rely on being told what to do by your favorite personal finance personality. There can be circumstances that make this strategy a safer play.

Interest rates are projected to continue their rise in the coming years (they certainly can't go much lower). This means rising housing expense for those prospective homebuyers currently on the sidelines and saving for their downpayment and savings cushion (remember, you need money for furniture, drapes, etc.!). In order to lock in your housing payment at today's low-low rate, you might justify borrowing from your 401(k) for your downpayment.

You can usually borrow up to half your 401(k) balance up to $50,000 and employers will give you between 5 and 15 years to repay it. Also, this "debt" does not count toward the debt to income (DTI) ratio that your mortgage professional and lender will use to underwrite your loan. Further, the loan will not be reported to the credit bureaus and display on your credit reports. In addition to locking in today's very low interest rate for your housing payment, if you can come up with at least 20% downpayment you can avoid paying the additional loan cost of mortgage insurance.

Some people may have other financial assets such as stocks which they do not want to cash out to raise the money they need for downpayment and closing costs. This could change your outlook on the risk and rewards of borrowing against your retirement.

Do not ignore the pitfalls associated with borrowing against your retirement money. First, remember that you contribute to your qualified retirement plan with pre-tax dollars. Therefore,if you fail to repay your loan, the IRS will catch up with you and force you to pay tax on the loan dollars, plus you will have to pay stiff penalties. Second, if you are laid off or quit your job, you typically have a short window within which you must payoff your loan (60 - 90 days), or you will face similar tax expense and penalties.  You must weigh these dangers heavily in your decision.

As you can see, regardless of whether this is a good philosophy or not, it all boils down to math and running some simple calculations to help make an informed decision about the pros and cons.

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Sep 19, 2013 12:23 PM