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Level 1

401k Loan

Hello,

I'm overly stressed about my current financial situation. As I have a 22k personal loan and 20k in car loan. This does not include my credit card debts even though they are 0% now and I plan to pay them off before the end of the promo. Now I would like to take a loan against my 401k account to payoff my car loan and maybe sell it back to get a much cheaper car to be out of debt. I'm 33 Y/O and would pay off the 401k loa  in 2 years. Please advise if that is good idea financially.

Thank yoy

1 Reply
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Level 15

401k Loan

Depends on if you pay it off and if you get into even more debt on the way.

 

The legality is that, in most cases, your 401(k) loan payments must be deducted from your paycheck, so there is no way to default unless you terminate your employment.  But this means less take home pay.  You can usually choose a repayment time of up to 5 years, but you can choose a shorter time if you prefer.  If you do terminate your employment, the outstanding loan balance will be converted to a distribution and will be considered taxable income and subject to income tax and a penalty, unless you repay the amount before the deadline.  (The deadline used to be 60 days but I believe it has been changed to the April 15 tax deadline of the following tax season.)

 

As far as your credit score is concerned, the 401(k) is not reported on your credit report show it doesn't show up as a debt, but it also doesn't show up to your credit for making on time payments.  Don't close your credit card accounts unless that's the only way to stop spending on them.

 

Financially, the money you borrow will not earn gains in the stock market while in your hands.  If we look at last year before COVID, the market was up 20% or more, so if you had done this last January, you would have given up 20% market growth in order to save paying 0% on a credit card and 4-5% on a car loan.   Right now the market is way down.  If it jumps up after the virus is controlled, you might miss those gains.  But timing the market is really hard, and I won't even try and guess whether you will save more in interest than you give up in market gains.  

 

If you reborrow on the credit cards while still paying the 401(k) loan, you've doubled your problem.  This is what happens to most people who consolidate loans without controlling their spending as well. 

 

I personally would not take the 401(k) loan if I could pay off my debts in 2 years without the loan. 

*Answers are correct to the best of my ability but do not constitute legal or tax advice.*
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