My money question is about taking a low interest loan from my company 401(k). My sister has suggested this as a way that my husband and I can pay off our high interest credit card debt. What do you think?
Thanks for the question. I am happy to hear that you and your husband are seeking ways to get out of debt. I can think of several reasons why taking a loan from your 401(k) could hurt you.
First, the money that you borrow out of your long-term “don’t want to be a bag lady” account will not be available for growth while it is out of the account. That’s was the expectation when you put the money into it via payroll deduction. Don’t short circuit your earlier plans.
Second, is that if you leave your job (you quit, get fired, laid off, have to retire early, become disabled, etc.) you will have a VERY short period of time to pay back the entire loan balance. If you cannot pay it back quckly, whatever balance is left outstanding will be “forgiven” and counted as a premature taxable distribution and you will have to pay income taxes on that money and if you are not yet 59 ½ you will also have to pay an additional 10% penalty. I have seen this happen.
Third, (and this is the biggest of the three) is that borrowing against your 401(k) is just more borrowing – it does nothing to address the root problem (overspending your income). More borrowing only masks the problem. It doesn’t really solve anything.
Borrowing from one’s 401(k) would make perfect sense ONLY IF the issue is that your past overspending was financed by borrowing from the wrong place (from credit cards instead of from your 401(k). But that’s not the case. The issue is spending vs income.
MMQ feels much the same way about debt consolidation loans or a HELOC to pay off consumer debt. They seems logical, and the interest rates and tax advantages often favor the strategy, but I have seen it go bad MANY more times than I have seen it work out. If the underlying problem isn’t solved (too much spending for a given amount of income) then the problem will come right back, and often be worse than it was in the first place.
You and your husband may eventually decide to assume these risks and borrow against the 401(k) to leverage the lower interest rates and make the debt payoff go a little faster than it would otherwise, but don’t even think about doing so until you have proven to yourselves over 9 to 12 months that you have learned to live within your means and you have been paying off your debts on a steady basis.