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401k Home Loan

Almost every company today offers its employees to make contributions to a company-sponsored 401k plan in order to provide financial resources for their retirement years. Therefore, if you have been wise enough to open a 401k account you may enjoy the opportunity of taking a loan guaranteed by the money you have accumulated in the account.

It is important to make a distinction between withdrawing money from your 401k plan account and taking a loan against the 401k. Generally, you are given the opportunity of borrowing no more than 50% of the balance of the retirement account. The interest you are to be charged is comparable to the Prime rate. The good news is that you are not penalized by any fees when taking such a loan. The payments you should make to cover the loan are deducted from your monthly salary. When applying for a loan you should clearly state your reasons since they provide the basis on which the repayment period is determined. The maximum amount of time is 15 years.

In order to clarify the goodness of borrowing money against your 401k plan, imagine you are 35 years old. You have been working for your employer for ten years and have invested in the company-sponsored 401k plan during this period. As a result you have accumulated $50,000. Unfortunately, a time comes when you need some money you cannot provide with the cash you have at hand. So, you turn your attention to your 401k plan. Since you are allowed the amount of your loan to be up to 50%, you will be able to borrow $25,000. This loan option is more appealing than the ones that other financial institutions (such as banks) offer since the terms of repayment and the interest rate charged are significantly lower. Since you will not retire in the near 25-30 years, and you have to repay during the following 15 years, you decide to take advantage of this opportunity. And, may be you have taken the right decision.

Nevertheless, there are several issues that require immediate attention before you take any actions toward borrowing money against your 401k plan.

  1. Since by borrowing money from your 401k plan account you will reduce nearly by a half the assets held, you will deprive yourself from greater returns and compounding.
  2. You should have in mind that the repayment installments are after taxes, even though your 401k contributions are made before taxing your salary.
  3. You should consider for how long you will stay with your current employer. This consideration is required since if you decide to change your job before you have repaid the loan you may be subject to penalties and taxes. Or, your employer may require the full repayment of the loan.
  4. Unfortunately, the interest rate you are charged on a 401k loan is not tax deductible as compared to the interest rate charged on a mortgage or a home equity loan.

Having all these drawbacks of 401k loans, you should carefully consider whether you can afford to take such a loan and whether the other loan alternatives don't represent a better option.

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