Good question that i’m asked alot about!

Should you borrow from your 401(k) plan to payoff debts?

Some might argue that it makes sense as you’ll end up paying yourself back with interest.
If you have money problems, borrowing from your 401(k) plan may seem like an easy answer. In fact, in theory, it makes sense.

But, in most cases, it’s anything but a good idea and here’s why:
1. Borrowing from your retirement plan can and will cost you a fortune. You’ll be losing years of tax-free compounding interest for every dollar you borrow.

2. If you leave your current employer, you will probably be required to pay the loan back immediately. If you fail to pay it back in full and on time, you’ll be faced with paying steep penalties and tax charges. This is money that also could have been compounding for years to come.

Here’s an example of what it could cost you in compound interest if you were to borrow from your plan:

Let’s say you borrowed $10,000 which you would’ve been getting a 6% rate of return. Over 5 years, that $10,000 would be worth $13,382 and over 10 years, that initial amount would’ve grown to $17,908.48. But you wouldn’t have seen any of that increased value because you withdrew the funds. Now granted, you would’ve paid off $10,000 in debt but my point is that you need to explore all the options available to you.

Here are a few:

1. Mortgage refinance or home equity line of credit. You could pull the equity out of your home to payoff your debt. The interest would be tax deductible but what you’d need to be mindful of is to accelerate your payments as much as you’re able and as consistently as you’re able so that you don’t stretch the payback over years.

2. Unsecured debt consolidation loan. Although the interest is not tax deductible and the interest rate will likely be higher than a mortgage refinance or home equity line of credit, it’ll still more than likely be lower than your high interest rate credit cards.

Whatever you do, do your homework and remember that knowledge is power!

Any questions, contact me at coach@debtfreediva.com

Dee Dee Sung
www.debtfreediva.com

This entry was posted on Wednesday, October 12th, 2005 at 11:19 pm by Debt Relief Blog and is filed under Debt Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.