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Wednesday, February 04, 2009
Carrie Schwab Pomerantz :: Townhall.com Columnist
Borrowing from Your 401(k): Is It Ever a Good Idea?
by Carrie Schwab Pomerantz
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Given plunging stock prices, declining home values and the rise in unemployment, it's no surprise that many Americans are looking for ways to get their finances in shape. For example, recently I got a question from a reader asking if it was a good idea to borrow money from her 401(k) plan to pay off high-interest credit card debt.

While my initial gut reaction was a resounding "no, don't you dare," I reconsidered. Without doubt, your retirement account is a crucial component of your long-term financial plan; for many people, it is the crucial component. However, if you understand and follow the stringent rules for 401(k) borrowing, and if you are extremely confident you can pay the money back in a timely fashion, this can be a smart move. But caution lights abound; think carefully before you leap.

Understand the Terms

Start by making sure you fully understand the terms at which you're borrowing. Typically, you can borrow up to 50 percent of your vested balance up to a $50,000 maximum (but note that some plans have different rules). Your rate will be quite low, perhaps 5 percent, and you'll most likely have to pay the money back within five years (note that if you're borrowing to buy a home, you have longer to repay the loan -- but that's a different story). Of course, you'll be paying the interest to yourself, perhaps through an automatic payroll deduction.

Understand the Risks

Now if you've got credit card debt at, say, 15 percent or even higher, then paying it off at 5 percent (back to yourself) can seem pretty attractive. And it is, both in a financial sense (lower total interest costs) and a psychological one (having no credit card debt can be a very good feeling). But there some significant caveats:

-- Your monthly payment could actually be higher. Credit card balances can be repaid in such small increments you can take years or decades to repay them. Your 401(k) loan will likely have to be repaid within five years. If you have a lot of debt, you may not see that much monthly relief, despite the lower interest rates. Continued...
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About The Author

Carrie Schwab Pomerantz is a Motley Fool contributor.

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(3 comments so Far)
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Reply # 1
Date: Feb 4, 2009 - 4:07 PM EST
In boom times
some of my colleagues adopted the practice of borrowing as much as they could from their 401(k) accounts. This always struck me as getting unnecessarily leveraged. But, to pay off high interest debt with a loan at lower interest, that you pay to yourself, makes sense. Even then, it is risky; will your current job stay in place long enough for you to repay the loan? At almost any time a yes answercannot be given with full certainty.

Several years ago, on my 59.5 half-birthday, I immediately felt better about my 401(k) balances, even though they stayed right where they were, in stable value funds.
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Reply # 2
Date: Feb 4, 2009 - 2:39 PM EST
Good advice, Carrie
I think, especially in this economic environment, borrowing from a 401K to pay off credit card debt is incredibly stupid. If you lose your job - as hundreds of thousands of us have recently, you have to pay back the ENTIRE AMOUNT right away. Also, most people get into high credit card debt because they don't control their spending. CUT UP THE CREDIT CARDS!!! Don't even use your home equity line unless you have at least an 80% loan-to-value even with the HEL borrowed to the max. A lot of people who are losing their homes these days have borrowed more than the house is currently worth because they used Home Equity loans to buy cars, vacations and pay off credit cards.

As Carrie said, unless the credit card debt is due to unexpected medical expanses or some other one-time event (which is usually isn't) the best thing to do is to STOP SPENDING, cut up the cards and then start paying off the balances.
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