Benefits of 401k Loans
A 401k is essentially your money and it is perfectly legal to borrow against your own 401k plan, but what are the pros and cons? On the side of the cons, you are borrowing money from yourself and you still must pay fees and interests, you may end up paying tax twice on your money, and you must establish a repayment plan that will come out of your current pay in order to pay back the loan. It is not a one sided deal of course and there are pros too. For one thing, you are paying the interest to yourself and you will also be able to take out any size loan that you need as long as you have enough money in your 401k.
The cons of taking a loan against your 401k are pretty substantial however. There is often a set fee to pay no matter the amount you take out of your 401k. The fee might not sound like a lot of money but it can add up to a substantial sum, especially if you are taking out small loans every once in awhile. In addition to fees, you will be required to pay interest on the loan you have taken out just the same as if you had taken the money from a bank or other lender. By no means is borrowing money from your own 401k free. There are also issues with compounding interest when borrowing against your 401k. Besides paying interest on the loan amount, you are also not earning money on your money while it is outside of your 401k. This means that for every year that you have against your 401k, you are losing a substantial percent of your potential earnings. You also have a set amount of time to pay the loan back which you must establish at the time of taking the loan, often between one to five years. Worst yet; remember that you have to pay taxes on money spent as well as income tax on your 401k when you begin to utilize it. By taking a loan on your 401k, you are essentially paying tax on your retirement money twice.
This is not to say that there are not benefits to taking a loan out of a 401k though. One huge benefit is that the money is essentially yours to begin with and any interest you pay on the money is technically still yours, it is just going back to the 401k plan and being invested until later. Another benefit is that you do not require any co-signers or credit checks to take out any size loan that you might need as long as you have that amount in your 401k. The money is readily available to you and free to utilize for whatever purposes that you might need. If you default on a loan for whatever reason, while the penalties are harsh, they are not nearly as harsh as defaulting on a bank loan. You will end up paying income taxes on your 401k and you will suffer a ten percent withdrawal penalty for early withdrawal. These are minor compared to the horrors of bankruptcy or defaulting on your mortgage and losing your home.