If you have thoughts of buying a new house, but you cannot afford the down-payment, extra-design work, or anything, you may think to take a 401k loan. Everyone around you may advise you to take a 401k loan too. You may feel that it is a better option when in an emergency situation. But it’s not the right decision.
Everyone may tell you that it is a great loan, and you have to pay it off afterward. Or, it is a low-interest and low-risk loan without too much processing work.
Everything sounds good until you see the reasons why I advise you never to borrow money from 401k.
1). Typical Five Years For Repayment
If you take a 401k loan, you need to pay the entire amount within five years of taking the loan, including interest.
You can extend the repayment period depending on the loan you take.
Most of the time, you would opt for five years, as that’s how 401k loan rules were created.
You need to pay the interest and the full amount back within this period, which is often pulled out of your paychecks.
2). Not Saving Money
When you borrow money from the 401k loan, most of the time, you would have to save more money for the payment of your loan because of interest. If that’s the case, as it is for many, you wouldn’t be able to save for your other contributions.
You can’t save any part of your money for any other necessary spending. Eventually, you wouldn’t be able to afford anything for future savings.
Thinking of taking a 401k loan and paying yourself would make it so that you couldn’t save anything in the end. In most situations, this would not be the situation unless you borrowed money from the 401k loan.
3). Fees Charged For Keeping a 401k loan
When you have a 401k loan, you would think of it as a low-interest loan. But to keep that, you must pay an annual fee for the administration costs. Most of the time, all the plans would charge you an origination fee of approximately $75 or more. This fee would be added regardless of the size of the loan.
There is another fee called “asset-based fees” charged by mutual funds when your plan is invested, and it is tough to see in the statement.
4). Not Able To Spend On Entertainment
As a 401k loan makes you save more money to repay it, you can’t spend a lot of money on any extra entertainment. If you want to go for a vacation or celebrate a big festival, then you should, in a typical scenario, have to use the saved money for such costs. However, with a 401k, you wouldn’t have any cash kept at that time.
You have to be very conscious about what you’re spending and how much you are spending.
5). Prepare Yourself To Stick To One Employer
The 401k loan will cost you to pay the entire amount in one go when you shift from one employer to another. The time limit IRA gives for the payment is 60 to 90 days.
When you want to take a 401k loan, you should prepare yourself to stick to one employer for five years even if you get an excellent opportunity to switch employers. It is one of the most painful points of taking a loan as most people would like to change jobs for their career growth.
Consider this reason so that you can be prepared for the consequences of taking a 401k loan. It is one of the main reasons why I advise you should never borrow money from 401k.
6). Losing 401k Compound Interest
If you’re thinking about taking a 401k loan for five years, then you should know that you’re at risk of losing your compound interest on your retirement account.
When you take away the amount you’re paying for your 401k, you forget that amount that would help you in the future in any urgent situation.
When you pull the money from all your savings in 401k, you can’t save the money back at some other time. It will be arduous for you to get the same amount into your 401k again.
That is the most significant point as to why you should never borrow money from 401k.
7). Situations May Get Complicated
If you pay your money for the 401k loan, you should consider what
might happen if an emergency comes along. You may require money very badly. That situation may be anything. But if you need the money urgently, you would have to spend the 401k cash, which you saved till that time, on it.
Then you might have to live paycheck to paycheck for other things, too, apart from the loan. It would again limit the boundaries of your expenditures. It will make you feel crushed when you are trying to get away from the loan you took.
That should make everyone think more before borrowing money from 401k.
8). Taxes You Should Pay
When you can’t pay the money within the given time, you have to pay the extra tax amount for the loan you have taken. Also, you’ll have to pay the penalty with the taxes you’re paying.
The remaining amount you have to pay will be considered income, and you need to pay the tax plus a penalty for that.
9). Need to Pay Full When You’re Out Of Your Job
Everyone talks about 401k loan benefits until the time comes when employers have to lay people off. If you lose your job, the situation will become worse. You will have no way to earn money, let alone extra money to afford things like entertainment.
You will have to pay your full loan amount within 60 to 90 days if you lose your job. You need to consider and check this factor thoroughly before taking a 401k loan because this will affect your credit score.
The people who got fired or laid off would be in a terrible situation when they can’t pay back the loan amount.
10). Feeling Bad Situation
For five years, the payment will be made one after another. You will have to maintain a proper plan for tackling each need that comes on your way. It would be best if you had to create a backup for every plan as well.
If you tackle the situation correctly, then you are on the correct way to face the next one. Otherwise, if you fail at handling even one thing, everything will collapse, and you will have to toil to pay for the failure.
So you should be very cautious when you take the 401k loan, and it is crucial to make sure that nothing falls badly in your way if you want to pay off your loan on time. Also, this is one of the critical reasons to stay away from the 401k loan.
According to your needs, you can take a 401k loan. But before going to take the loan, you should consider these above-said things to know the ups and downs of borrowing money from 401k. I hope these reasons will help you make the right decision before going for the 401k loan.
If you want to take a loan for a very much-needed situation, consider looking for other options than 401k, as it will be tough for you to handle it.
Do you have any other options than 401k? What do you think of 401k? Do you think you shouldn’t borrow money from 401k? Or have you taken a 401k loan already? Please provide your valuable comments below.
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