401K Loan VS Credit Card Loan? | 401k Questions

Question

Asked 3/5/2008

401K Loan VS Credit Card Loan?

A lot of people talk about not to touch 401K, I just wonder what others think if I have the needs to borrow $10000. Should I take a loan from my 401K or from Credit card ? if I take a loan from my 401k the interest will be at 8.25% and max time is 5 years to repay, however the credit card interest rates is 21.7% and unknown when is time limit to repay. I don't have any other access to the funding except my 401K and credit card. Your opinions is appreciated.

Answers

Answer 1/5 - Submitted 3/5/2008

On it's face, the 401K loan seems better, but there are lots of strings attached. If you chose the 401K loan route, you should be 100% certain that you would be able to honor the terms.

(1) You can borrow up to 50% of your vested balance, up to $50K.
(2) You must repay the loan within 5 years, unless the loan is to buy your home.
(3) Loan repayments must be made at least quarterly and must be "substantially level," meaning about $500 or more per quarter.
(4) If you default on the loan it would be treated as a distribution; there could be a 10% penalty + taxes and $10K less in your account (and that much less to earn returns).

Some credit cards give cash advances with reduced rates. I've been offered 0% for 6 months or 5% for the life of the advance. Call your credit card company and ask if they have similar offers.

Also, consider talking to your bank for an unsecured loan. $10K isn't all that much money, and if your credit and income is okay, you may be able to get it.

Personally, tapping into retirement has always made me nervous. I would do almost anything to avoid it, including taking a part time job or selling something big.

Good luck!

update: I added another link that explains the consequences of taking a 401K loan very well. One important thing I just learned: If you leave your job, you may be required to pay the balance of the loan on your way out the door or take the balance as a distribution. That could be very painful either way, especially if you happen to get fired or laid off.

Answer 2/5 - Submitted 3/5/2008

Definitely the 401(k) is the way to go but don't take 5 years to repay it.

Answer 3/5 - Submitted 3/5/2008

My unqualified view on this topic is this....if you REALLY need money that you don't have saved or "liquid" then look for some creative (tax friendly) financing. Credit Cards are not tax friendly (interest paid that can reduce your adjusted gross income). On the other hand, mortgages, equity lines and those types of vehicles are. If neither of those programs are available to you there is the 401K route. Now, a loan on your 401K is not really a loan because you are borrowing from yourself. The interest paid on the loan is the best kind of interest you can have. You are paying the interest back to YOU! minus any nominal lending fees involved with setting up the "loan". You do need to take into consideration the fact that it is typically a 5 year payback for up to $50k, but $10k + interest is more manageable over that term unless of course you are using the money to buy a home, then you have 10 years to pay back. Another thing, you are guaranteeing that your 401k will get 8.25% over the life of the "loan". Everytime you make a payment, that money goes right back into the market. I bet if your like me, your 401k has been sucking wind over the last 6 months with no relief in sight. If for some reason you cannot pay the loan back (which would be the same if you used a credit card), it would not affect your credit report because you are borrowing from yourself, you would incur a 10% IRS penalty (on the outstanding loan amount) if you are under 59 1/2 years old. That remaining distrobution would be counted in your adjusted gross income for that tax year. Let me finish by saying....IF YOU REALLY NEED THE MONEY that you don't have already saved, there are choices out there that are smarter than others. Putting money on a card IMO should be the last option.

Answer 4/5 - Submitted 3/5/2008

Why do you need the money and for how long?

Most good needs for money will have another financing source available. Are there credit card options with lower rates than 21%?

Answer 5/5 - Submitted 3/5/2008

21.7%??? don't you get offers any lower than that??? Credit card loans are like throwing money out the window...but a 401k loan would be no different if you don't pay it back. So be prepared to pay it back and not leave your job during the next 5 years. Also, it is critical that you do not stop your normal contributions...you have to continue them or you'll cost yourself in the long run...far more than that 8% interest!!!

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