Borrowing from a 401K - Good or Bad?

When is borrowing from a 401K good?


Most 401-K plans allow employees to borrow a certain percentage of the balance.  The loan is paid back with payroll deduction over a term defined by the program.  The great thing, is the interest paid on the loan goes back into the 401-K.  This interest may be more than most people made last year in their investments.  The HUGE drawback to borrowing from a 401-K is that the loan is due and payable upon termination.  In other words, if the employee finds another job or is laid off the loan must be paid back.  If the loan is not paid back, the distribution is treated as an early withdrawal.  The early withdrawal comes with taxes and additional penalties.

The potential for paying early withdrawal penalties adds a big risk to borrowing from a 401-K.  Having said that, many people are choosing this route as a way to take advantage for the $8,000 ot $6.500 home buyer tax credit.  First time home buyers are borrowing $8,000 from their 401-K's, buying a house, then paying the loan back with the tax refund.  The risk of borrowing from a 401-K is reduced because the tax refund can be processed fairly quickly after closing.


To be clear, I'm not advising anyone to borrower against their 401-K.  Every situation is unique before you do this, you should consult your 401-K company and a licensed investment adviser.  If you don't have an investment adviser, I can connect you with one.