When it comes to taking out a 401k home loan, you may be wary. Your 401k is your nest-egg for the future, but if you need money fast, it may be your only financial option. If you aren’t sure whether you should take out a 401k home loan, here are some pros and cons to help you make the decision.
Pros of 401k Home Loans
- Income Tax-Free: A 401k home loan will not incur any income tax or penalties for withdrawal unless you default. This means that you’re required to make regular payments and as long as you do, the loan is income tax-free.
- No Credit Check: When you get a regular loan, you’re subjected to a credit check to determine if you’re eligible for a loan as well as the amount you can borrow. When you need to withdraw a 401k home loan, there is no credit check, meaning your bad credit won’t hold you back from borrowing against your 401k.
- Longer Terms: Other 401k home loans have a short-term duration. It’s usually required that you pay back the loan within five years, but a 401k home loan has much longer terms. The amount of time is determined by your employer.
- Interest to Yourself: When you take out a 401k home loan, you’ll have to pay interest like any other home loan. However, instead of paying a bank, the interest from your 401k home loan goes back into your retirement account, meaning you’re essentially paying yourself.
Cons of 401k Home Loans
- Must Show Financial Need: Many employers only allow you to withdraw from your 401k if you show financial need. Overall, this can make it much more difficult to get a 401k home loan. Other sources of financial assistance can include borrowing from a bank or a savings account.
- Less Retirement Fund: When you borrow from your 401k, you’re reducing the amount of money you’re making over time. The funds you take will not grow with the rest of your 401k, which can amount to a lot of money lost from your funds when it comes time to retire.
- Due Upon Unemployment: If something happens where you’re no longer employed with the company, it’s required that you pay back your loan within 90 days. Failing to do so can result in the amount being taxed as income and additional fees from the IRS of 10% for early withdrawal if you’re under 59 and a half.
- Limited Borrow Amount: Borrowing from your 401k has specific limitations. You can only take 50% or $50,000—whichever is the least. If you’ve saved up $24,000, 50% of the loan amounts to $12,000, which is below the $50,000 limit. However, if you’ve managed to save $150,000, you’ll be limited to only $50,000 because $75,000 is over the limit.