Borrowing from the 401K: The Best of a Bad Situation

After Monday’s post about not borrowing from the 401k, I had a thoughtful comment from someone who’s done just that and offered to share her experience. In my opinion, if you had to borrow from your 401k as a last resort, here’s how you should go about it. Here’s the comment from Cheapskate who blogs @ Yes I Am Cheap:

“Let me speak from the experience of someone who HAS borrowed from my 401K.
1. I borrowed from my 401K at 28 so I knew that I had quite a lot of time to repay the money. The loss in potential interest did not bother me too much. I also made sure that the repayment period was as short as I could afford it to be. I did not want to extend it.
2. I made the interest rate as high as the return that I had been getting on my money. Thankfully I borrowed the money right before the recent crash so I actually ended up preserving some of my money since my portfolio lost 35% last year.
3. I was in dire need on the money and had no other place to come up with the large amount of cash that I needed in such a short amount of time with an affordable interest rate. I would not recommend borrowing money to purchase a car or finance education or something like that but if it comes down to borrowing against the 401K and being out on the street then I am all for tapping that cash.
Everyone has different situations but you should be fully aware of what you are getting into. Know that you have to repay immediately if you separate from your job. Know that you have to pay both penalties and interest if you do not repay. Things like that could make you pause. Know that the loan is paid back with AFTER tax money.
I did what was right for me at the time and in 8 months or 16 payments from now I will be free of the 401K loan, freeing up a full $400 per month to smash my other debt. It also taught me how to live on $400 LESS per month while still contributing 6% of my pretax income to my 401K so I will nor return to my old ways.”

Thanks for sharing Cheapskate, and good luck getting rid of the debt and blogging your efforts at YesIAmCheap.com.

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Jared Grubb

I am always a little annoyed that "repaid using after-tax money" is listed as a downside to 401k loans, as though this is something unique to this kind of loan.

If you're trying to pay for X, then no matter what kind of loan you take (401k, bank, family, etc), you're going to repay the loan using after-tax dollars... Even if you dont take a loan and you pay for X using your savings, that money is after-tax dollars and will be replenished with after-tax dollars.

The only reason we need to remind people that the loan is "repaid with after-tax dollars" is to dispel the notion that somehow you get to short-circuit the tax system by paying for something using pre-tax 401k dollars and ALSO get to replenish it using pre-tax salary dollars... The IRS certainly would never let that happen :)

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Miranda

Thanks for sharing this story! While it may not be the best thing to borrow from a 401k, it sure beats borrowing from someone else. I think the key is to use it as a last resort in an emergency and pay it back quickly.

Link is correct now. Thanks for the comments.

Cheapskate Sandy

PT,

Thanks so much for featuring my comment! I was really in a dire situation and there was 30K sitting there in the 401K. I had been participating in a 401K of some kind since I was 18 so I recognized the benefits of a 401K pretty early. I was making very little since I was still in school but I still managed to contribute at least 3% of my paycheck. None of the companies that I worked for did any kind of matching so it was all my money and 100% vested.

The only problem that I have now is that I want to make extra (snowflake) payments above what they are taking from my paycheck but Fidelity doesn't allow you to do that. It was to be a 100% payoff check or just the regular deduction from your paycheck. Anyway, thanks so much!

the weakonomist

That is certainly a best case scenario for borrowing money. Unfortunately most people who do borrow won't be so lucky. They'll either run out of money again, waste the borrowed funds, or simply be too lazy to make the effort to pay off the loan in a reasonable amount of time.

I wish you could not borrow from the 401(k). Either make it so they can cash it out and pay the fees or so you can't withdraw with intent to repay.

PS, as of early this morning the link to the commentor's website does not work.

Borrowing from the 401K: The Best of a Bad Situation

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