With more companies providing a 401k plan as part of, or the only retirement plan it offers, people are finding themselves more in control of their own retirement planning. Most 401k plans allow you to take out a loan from your account. Before you do, it would be wise to learn the pros and cons of doing so.
Pros
Some plans require little more than a phone call to get the loan, making it very convenient.
It’s your money that you’re borrowing, so there is no credit check. Usually, your company will have control of the money, but normally will have no problem with you borrowing from it.
The interest rate you pay is low, usually one or two points above prime, and the interest you do pay goes back into the account. So, you are paying yourself to borrow the money.
With some plans, you can even choose which investments the money comes from. If you have an investment that is doing really well, you won’t want to take money from it.
Cons
The interest you pay on the loan is usually less than the interest the money would be making if you had left it in the account.
You may decrease your contributions to free up enough of your paycheck to pay the notes on the loan. This will cause your potential earnings to be less than if you hadn’t done so.
If your employment is terminated, the loan may become due in full.
The payment terms are fixed at the time you make the loan, and cannot be changed. So, if you find yourself having a hard time making the payments, there is no restructuring available. You will still have to come up with the money to pay the notes each month.
Some companies stop contributing to the plan during the term of the loan. If your company usually contributes, you will not be eligible until your loan is paid back. You may not have the option of paying the loan off early.
You may be charged a fee for the convenience of borrowing from your plan.
Conclusion
A conventional loan from a bank or other financial institution should always be your first choice when borrowing money. If you cannot obtain a loan, then you may have no choice but to borrow from your 401k plan. When doing so, ensure that you absolutely need the money, borrow as little as you can get by with, and don’t stop your normal contributions during the term of the loan. Remember, the whole purpose of your 401k is to fund your retirement.