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Is it Ever a Good Idea to Borrow From Your 401(k)?

By JLP | June 5, 2006

Is it ever a good idea to borrow from your 401(k)? I saw this article in the Charlotte Observer, which offered this “do” advice from Eric Tyson:

Do: Borrow 401(k) money if it is your only means for a down payment on a house or to help pay for college for you or your kids, both of which are investments, said Eric Tyson, author of “Personal Finance for Dummies.”

Although I don’t necessarily recommend it, we borrowed from our 401(k) in order to come up with the down payment and closing costs on our house. When you take out a loan from your 401(k), the funds inside your 401(k) must be sold and the proceeds are loaned to you. You pay back the loan with AFTER-TAX money, which is deducted from your paycheck. In hindsight we borrowed at almost the perfect time as we sold our mutual funds at the market peak and bought them back during the downturn. This meant we were buying back the mutual funds for 15 – 20% LESS than we sold them. For us it was great.

As far as borrowing from a 401(k) to pay for college: I think I would exhaust all other funding sources before tapping a 401(k).

One important thing you need to remember about 401(k) loans: if you take out a loan and leave or get fired from your company, you must either pay back the loan immediately or you will have to pay taxes PLUS a penalty on the outstanding amount, which is definately NOT a good deal.

Topics: 401(k), College Funding, Financial Planning, Retirement Planning | 6 Comments »


6 Responses to “Is it Ever a Good Idea to Borrow From Your 401(k)?”

  1. Rethink(IP) Says:
    June 5th, 2006 at 9:14 am

    Carnival of the Capitalists – CoTC – Rethink(IP) Redux

    Well, ask Steve said earlier – we are at it again. Welcome the the June 5th edition of the Carnival of the Capitalists.  Lots of good things to read and plenty of information for everyone. My special thanks to Brian…

  2. Foobarista Says:
    June 5th, 2006 at 4:42 pm

    One question I have: are 401K loans simply liquidations of your account that you pay back, or is it a separate loan that is secured by money in your 401K account (similar to a stock margin loan)? (I think it’s the former, but not sure.) This matters enormously, since in the former case your loan principal is out of the market until your loan is paid off, while in the latter it would still compound while you were paying down the loan.

    If it is the latter, your real interest on the loan would be the interest rate of the loan itself + the lost appreciation from the loan principal in the market. This sounds like really expensive money…

  3. JLP Says:
    June 5th, 2006 at 5:01 pm

    Foobarista,

    I’m not sure if ALL 401(k)s are the same but I know that the ours sells the funds that you are borrowing and the proceeds are loaned to you.

    It can be expensive money if you do it at the wrong time. My wife and I were lucky (blessed?) that we sold out close to the top of the market.

  4. Ike Says:
    July 4th, 2006 at 12:07 pm

    I think the #1 thing to consider when thinking about taking out a 401k loan is whether or not the return you’re losing by withdrawing the money from your 401k (and losing the compounding interest forever) is less than the return you’re going to get from the asset you purchase with the withdrawn money.

    As long as you purchase an appreciable asset with the withdrawn money, you can’t go too wrong.

  5. mariwhite Says:
    July 8th, 2008 at 5:07 am

    So,…. I’m thinking of borrowing against my 401K – and trying to figure out if this is a “not so bad time” to do it. The way I’m looking at it is this – I’m taking money out of my retirement portfolio and run the risk of losing compounding interest – but in this market – It seems like I’m running an even bigger risk of losing more of my portfolio value. At least by borrowing, I know I’m getting a specific amount back into my account – the loan amount plus pay back interest – unlike what’s going on in the stock market right now. I’d be putting the loan money into a home improvement. Anyone care to comment? Also, does anyone know if you can prepay a 401k loan?

  6. Chris Hyman Says:
    October 1st, 2010 at 2:58 pm

    In our company’s retirement seminars, they generally recommend NEVER borrowing against the plan, which I think is completely wrong.

    1-We work at a Cooperative. Losing one’s job is rare in this situation. Generally, if you’re competent and want to stay, you’ll have a job. I realize many aren’t in this situation, but we were.

    2-I used the loan to buy a used car, at a better rate than I could have gotten elsewhere (and I paid that rate back to myself).

    3-I had the Title instantly. It was my car at that point, no matter what. A loan from anywhere else would not have allowed for that.

    4-I took out the loan in October of 2008. My 401K stuff, except for that loan portion, tanked, and like you, for the next two years I’ve bought my funds back at a discount, plus earned a better percentage from the loan than most of the rest of 401K got. . . that percentage going to me rather than a third party (who would have kept the Title until the loan was repaid, if I’d gone that route).

    In summary, I think there may be good reasons not to borrow from your retirement . . . but in my case, I haven’t run across any of them yet.

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