 Pay off second mortgage with 401(k) loan? No!
|  Dear
Debt Adviser,
I have thought about taking out $50,000 out of my 401(k) to pay off my second mortgage. My thought behind this is that I will be paying myself the interest rather than the bank. I have calculated what the payment would be and can afford this. Why does this sound too good to be true?
-- Corey
 Dear
Corey,
Not since my cousin Glenn turned down a job with Microsoft in the
'70s to work for a local credit union for $500 more a year have
I heard such a bad idea! It does sound too good to be true, because
it is, especially if you consider losing upward of $100,000 in retirement
savings a bad thing.
On the surface, borrowing from your 401(k)
seems like a win-win situation: You don't have to qualify for the
loan, the interest rate is good (usually prime or just above prime),
you are paying interest back to your self rather than to a lender,
and by borrowing, rather than taking an early withdrawal, you avoid
the 10-percent penalty. Sounds good, huh?
Now, to avoid "Glenn's Folly" (sorry cousin),
let's look down the road and see what the future holds. The most
damaging disadvantage of borrowing from your retirement plan is
the loss in future growth of your retirement fund. Borrowing dramatically
affects your bottom line. For example, let's say you borrow $50,000
that you pay back in five years with 7-percent interest. Your 401(k)
is earning 10 percent. You are eligible to retire in 20 years. Your
fund will be short a net $110,673 at retirement due to the loan.
Run the numbers yourself on Bankrate's "Should
I borrow from my 401(k) plan" calculator.
If that's not bad enough, let's consider one of life's inevitable
curveballs. If your job gets eliminated, your loan then becomes
due in full and you are unable to repay the loan, then the loss
increases to $431,404 because of taxes and penalties.
Whoa! That $50,000 loan seems a little more costly now, doesn't it? As people are living longer and relying on retirement funds more and more, raiding funds set aside for the golden years becomes less and less wise.
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Big disadvantages of borrowing from 401(k)
include: |
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With all this said, borrowing from a 401(k)
or other retirement account is better than taking an early withdrawal
and, in some instances, might make sense if no other options are
available and you need money fast. I would, however, recommend you
spend time researching all your options and the ramifications before
borrowing.
Corey, my advice to you is keep paying off that second mortgage with today's money and leave tomorrow's retirement money alone. You're going to need it!
Good luck!
The Debt Adviser, Steve Bucci, is the president
of Money Management International Financial Education Foundation
and the author of "Credit
Repair Kit for Dummies." Visit MMI
for additional debt advice or, to ask a question of the Debt Adviser,
go to the "Ask the
Experts" page and select "debt" as the topic.
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