Don’t Fear the 401K Loan

Having trouble scrounging up money for the down payment on your new home, but you don’t want to build up interest on a bank loan? A frequently asked question that our Shea Mortgage team gets is, “Can I pull money from my 401(k) plan? And is there a penalty?” Fear not! The best option for you, if you are truly in a financial bind, is most likely a loan from your 401(k) plan.

These loans are best for a short-term need that you can payback within 1-5 years. They are also a good option because of their convenience, low cost and little to no effect on your credit. But if you don’t pay back this money within the short-term period, you will find that this loan is more expensive than you thought.

How do these loans work? Essentially, 401(k) loans are not true loans, because no lenders or credit checks are involved. You are borrowing money against yourself, which you will pay back to yourself so that this fund is restored to its original state. Also, interest is charged over the course of your payback period, but you pay the interest into your 401(k). The interest rate for a 401(k) plan loan is not as high as a bank loan would incur. Thus, pulling money out of your retirement fund can even have a positive impact.

You are only allowed to borrow up to 50%, or a maximum of $50,000 (whichever is less), of your own 401(k) money on a tax-free basis. If married, spousal consent may be required to take the loan.

The top reasons for pulling money out of your retirement plan are (1) for your kid’s college tuition, (2) to pay medical bills you were not reimbursed for, and (3) for a down payment on a home. A 52-inch flat screen TV? Probably not. Also, if you use the loan specifically for a home purchase, it is possible that your payback period can be extended past the maximum of 5 years.

Another thing to keep in mind about 401(k) loans… You must repay your loan in full before you change employers, quit working or you’re terminated. You will typically be given 60-90 days to do this. If you cannot repay the loan, you will be taxed on the unpaid balance. And if you took this loan out before you reached the age of 59 ½ years old, you could face a 10% federal tax on the unpaid balance. Here is where that hole in your pocket starts to develop if you do not restore your 401(k). Several fees can also occur.

To learn more about taking a loan from your 401(k) plan, watch our Homebuyer Seminar videos on YouTube, check out our Facebook page for updates, or look on our Twitter feed for facts! If you’re simply looking for fun home ideas, our Pinterest page offers several different boards for your creativity to prosper!