loan for home improvements
I'm considering taking a loan from my 401(k) at 4 percent interest.
The investment portfolio only earned about 3 percent over the past
12 months. I will spend the money on physical improvements to my
home, which I can conservatively expect to increase in value by
about 8 percent due to the improvements.
I live in an unusual historic neighborhood where home
improvements are highly beneficial and are consistently rewarded.
Is this a good use of retirement funds that show weak performance?
-- Matt Mortgage
If your retirement funds aren't performing well, that's good reason
to reassess how they're invested but not a particularly good reason
to borrow against them. Loans against your 401(k) plan should be
an absolute last resort in the case of a financial emergency, not
a funding source for home improvements.
The interest rate on a HELOC (home equity line of
credit) should be right on top of the rate you'd pay on a 401(k)
loan, plus the HELOC interest expense may generate a tax deduction,
lowering the effective rate on that loan to around 3 percent.
Even if your home's value is appreciating by 8 percent
annually, most home improvements don't recoup the initial investment,
much less track the local housing market. Remodelingonline.com has
an annual Cost
vs. Value report that tracks how well remodeling projects recoup
the owner's investment.
A 401(k) loan typically comes due immediately if you
leave your current employer. If you can't repay, the loan is treated
as an early distribution and you'll owe income taxes and a penalty
tax on the loan balance.
With some plans you can't contribute additional funds
until you pay off the loan. If it takes you five years to pay off
the loan, you've put your retirement savings on hold for that period
of time. Loan payments are made with after-tax dollars, so you're
replacing tax-deferred funds with after-tax dollars. If you can't
contribute to the plan while you have a loan outstanding, you're
also forgoing any company match.
To ask a question of Dr. Don, go to the "Ask
the Experts" page, and select one of these topics: "Financing
a home," "Saving & investing" or "money."