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Borrow from your 401k? Bad Idea!

Not that long ago, when you needed extra larger sums of money, where’d you get it from? Homeowners went to their home equity to borrow. Those have almost gone the way of the dodo bird.

What’s the popular source now to borrow from? 401k’s! Is that a good idea? Or a bad idea?

The common thought is “What’s the harm? I’m just borrowing from myself.” according to Ric Edelman in Top 10 reasons you should never borrow from your 401(k) plan. I won’t list the 10 reasons here since you can read them by clicking on his article. The point is – Borrowing from your 401k doesn’t work the way you think it does!

Unfortunately, too many people are learning this the hard way as Karen Weise points out in her article “In Spite of the Recovery, More Workers Are Borrowing From 401(k)s.” The largest offenders getting into problems later tend to be women, younger workers, and lower-income employees.

People tend to lump all debt together. You should understand that debt for consumption is bad debt. Paying months or years into the future for something you consumed yesterday is not how you get ahead financially,

Yes there is necessary debt for necessary things like improving your station in life through useful education. Or transportation to get to your job to earn money to pay for your standard of living is another example of necessary debt (buying a car – but overboard tips the scales to bad debt again).

A mortgage is an example of good debt – it for an asset that tends to grow in value over the long term for your shelter needs. But this scale got tipped into bad debt too trying to buy and sell in a short period of time. You see – most of the success stories in real estate are from people who owned for longer periods of time when real estate markets grew normally (not abnormally high during the mid-2000′s – which still tends to skew people’s perceptions on realistic historical real estate returns).

Here’s a blog on Basic steps to Reduce Debt.

Here’s an advanced calculator site (free registration the last time I checked) that provides multiple payment options on debt – you can compare them easily using the Power Pay tab.

Or … here are simpler calculators for debt payments (they both work on the same principle of paying extra – but how to do that best?):

  1. The Snowball debt elimination - on credit card debt, AND car debt, AND other debt.
  2. The Roll-Down debt elimination – on credit card debt only.

Moral of the story: Don’t resort to borrowing from your 401k – this will cost you in the long run. If you have other debt – work on it using one of the debt calculators above. Finally – understand the difference between Good Debt, Necessary Debt and Bad Debt.

Finally, regardless of the source of your debt, including a 401k, pay it off as soon as you can with higher payments! The more you pay, the sooner that monkey is off your back! The more you’ll save by not paying interest. And, more importantly, the sooner you can now take all that payment money and start saving it again. BIG HINT! Now save it – don’t get into nasty spiral where you now spend that “new found” money in your budget. You can’t get ahead until you have liquid savings and investments … in other words a Net Worth (you own more than you owe).

 

Photo source: By MIKI Yoshihito (Flickr: 401K – Perfect Solution !?) [CC-BY-2.0], via Wikimedia Commons

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Comment   |  3 years, 2 months ago from Roseville, CA