Loan from 401K or Reduce Contributions?

Updated on July 25, 2012
J.G. asks from Chicago, IL
20 answers

We need a bigger house, and we'd like to take advantage of this market. We have no equity due to the market where we live, and we have about 100k into this house we won't be seeing anytime soon.

Our current house fund only has 9k in it. We should have 15k just by saving by the end of the year, but I'm due with baby number 3 and we don't have a bunch of years to save. So, we currently max out our 401k and make a small Roth contribution. I was thinking of reducing our contributions in half, letting us almost double our savings rate.

Hubby thinks we should just continue with our contributions and then take a loan?

We aren't upside down on our mortgage. We'd get more than we owe but we paid a lot more for the house.

Anyone take a loan from thier 401k to buy a house? I'd hate to mess with our retirement since we are on track, but we need the space and should be able to make up the losses in the future by saving even more. I'm frugal, with no debt, so I know this is realistic. Hubby also has a good job in a high demand field.

I'm just not sure which is the most financially sound decision: reducing 401k contributions or taking a loan.

What can I do next?

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So What Happened?

The reaoson hubby wants o take the loan is that we are saving on the pretax dollors by making contributions, and the 10 percent tax on withdrawls is is less than the 30 percent tax rate we have to pay.

I didn't ask if we should stay put. I asked about loans. Hubby won't get fired, and if he did he would get 9 months pay---- more than enough to cover the loan and keep us in our house until he gets another job. He is in a high demand field, getting a job won't be a problem.

Mortgage professors seems to think that in some situations a loan from the 401k is the best option. We aren't talking about a big loan, maybe 20k max, which we could pay off immediately if hubby loses his job.

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answers from Dallas on

If he does it as a 401k loan that is not the same as an early withdrawl. A 401k loan does not have any tax penalty associated with it. The only thing is that it will be paid back in after-tax dollars and the payments will begin immediately.

If you take an early withdrawl, the tax effect is that you have to pay ordinary income taxes on it PLUS the 10% early withdrawl penalty. In that case, you'd be better off NOT taking it from 401k. However, if you take it as a loan, there is no tax effect unless you don't repay the loan. That can pretty much can only happen by leaving the job before the loan is repaid. In that instance, the tax implications would apply only to the unpaid balance.

I know a financial advisor would probably argue against a 401k loan, but I'm not a financial advisor :-)

2 moms found this helpful


answers from San Francisco on

You've gotten some great responses so I won't repeat those, I do recommend you talk to a mortgage person to see what it would take for you to qualify for a second home since it sounds like you are pretty upside down. It makes it more difficult to get the second home, you need more in savings, some places also require 20% down on second home. Good luck what ever way you decide to go.

2 moms found this helpful

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answers from Washington DC on

I would NOT take a loan against my 401K unless it was life or death. Why? because IF you lose your job - all the money is due immediately.

Regarding your husband's skill set: My husband was with the same company for 9 years - they laid him and a whole group off at once (40 people). He has great skills, education and a clearance - it took him TEN (10) months to get a job and we live in Washington, D.C. So do NOT EVER ASSUME ANYTHING ABOUT A JOB. "high demand" jobs change in a New York minute. The next new thing is "Cloud Computing Technology"....

Regarding the house? Is there a way for you to remodel or add on to the one you have instead of moving?

If that is not an option? I would suspend my 401K contributions until I have the money needed for the down payment. I would:

* find out how much of a home we qualify for and start looking to see if there's anything out there in my price range that will work for my family
* find out how long it would take to sell ours (guessing game) or rent it out
* get price quotes on moving our stuff (especially if your pregnant with #3)
* start getting my house ready to show for either sell or rental
* purge my home of everything I haven't touched in six months and either sell it at a garage sale, ebay, craigslist, freecycle or donate it.

Again - I would NOT take a loan nor would I do an early withdrawal on my 401K unless it was life or death.

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answers from Dallas on

Do not take out a loan on your 401K. IF your hubby loses his job, God forbid, that loan will have to be repaid in full plus any fees.

Delayed gratification....... this is when you delay something until you are ready financially to take on the burden without incurring extra debt.

Let's say this... you get a loan from 401K to get into the house you want. Hubby loses job, so you are required to pay back the 401K. You have a new baby, and OMG.... something is wrong with the AC, heat, water heater, etc anything and you are out MORE money to fix your house. It is a never ending downward spiral.

It is not the time for you to be moving up to a larger house. It is only time for that when funds plus more funds are available for the what if's.

The 401K and retirement is much more important than a house. You have almsot 3 children and they need college funds as well. Prepare for your future and your children's future and adjust to what you have.

You say you are debt free.... STAY that way. Debt is evil.

5 moms found this helpful


answers from Pittsburgh on

You can suspend your contributions--or reduce them.
Not a fan of the use of 401K money for other things.
Save up and get a convention mortgage.
And NEVER assume he can't lose his job and find himself underemployed! It happens all the time.
Your mortgage payment should be 25% of your net monthly income. Otherwise, you can't afford it. That rule has served us well over the years.
Good luck!

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answers from St. Louis on

Depends on how your 401k is structured. Some the interest you pay on the loan goes into your 401k so those are great since you are going to pay more in interest than you could make off your investments

The biggest thing is making sure you aren't going to lose your job. I know that is not something that you can predict but if it is already a question then don't go near that money. If you lose your job you must pay it in full or be hit with taxes and penalties!! It becomes like a withdrawal.

Looking at the other two answers I get the feeling they don't understand what a 401k loan is. They money stays in your 401k you borrow against it. So instead of having 40,000 in Camel futures you now have 40,000 lent to yourself. As you pay it back it goes back to other investments. You tend to lose nothing on the deal.

Okay, guys I am an accountant plus I work with payroll so we structure these loans. The only drawback is if you lose your job or quit you must pay it back before termination. If you do not only then will you be hit with taxes and penalties!

So far as the cutting back and saving you are losing the tax savings by doing that which means part of what you will be saving will actually be going to the government. So say your real tax rate is 20% and you divert 10,000 into savings you are only saving 8,000 because you will be paying 2,000 more in taxes. The transactions within a 401k loan have no tax impact!

Loans are not withdrawals!! You are investing in yourself.

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answers from New York on

In general taking a loan from a 401K is a really bad idea and should only be done for emergencies.

I read your so what happened and a lot doesn't make sense, especially "if hubby looses his job we could pay off the loan immediately". Where would you get the money? He's not working won't you need that money to live on? If you have that money, why take a loan?

The logic with the taxes isn't right. If you take a withdrawal (which is different than a loan) you pay a 10% penalty and in addition pay taxes on the income. If you're talking a loan (not a withdrawal), what type of interest rate would you be paying? Can you aford both the mortgage and the loan payment?

Of course, everyone's situation is different. Also, 401k plans vary greatly. So you really should talk to a financial advisor about your personal situation. However, I would NOT take a 401K loan. Start reducing your deductions.

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answers from Hartford on

Don't mess with your retirement. It's the worst thing you could do. Especially don't EVER take a loan out on your 401K. It's ALWAYS a bad idea. There are penalties and taxes on taking money out of things for a very good reason, and rewards for investing in them for a very good reason. They're NOT rainy day savings accounts but if they're treated like savings accounts you'll be paying worse penalties than a few hundred dollars in the short term. You heavily risk financial security in the future.

Please don't make the mistake of thinking that your husband's job skills in his field are invaluable and if he loses his job he'll have no trouble finding another. That's what this country's current unemployment rate is built on. People with invaluable, marketable skills in their field that employers should be willing to not only pay them top dollar for, but fight over them for. Every single worker in the work force with a job is replaceable and there's always someone out there who is better at the job than the supposed best person is. It's a really good idea to eat a little humble pie.

Anyway, talk to a financial counselor. They'll likely tell you the same thing but with better advice as to what you SHOULD do in addition to what you shouldn't do.

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answers from Boston on

I agree with Jo. There is no "penalty" for a 401(k) loan. The "penalty" is interest, which you pay back to yourself, and lost potential earnings. Many 401(k) plans index their interest rate to the Prime rate or LIBOR (sometimes plus 1-2%) so while it's great that the interest rate is now low, a higher interest rate would mean that you were forcing yourself to contribute more back into your funds via re-payment.

Statistics on the typical 401(k) borrower aren't flattering - most end up borrowing more than once, later take actual withdrawals, and have lower account balances and earnings. However, that's probably more reflective of the poor spending and savings habits of those who are typically more likely to need a loan. You don't sound like you fit that profile.

As Jo mentioned, the big risk is that if you lose your job, you do need to pay it back or get hit with taxes and early withdrawal penalties. Those aren't pretty! Another consideration is whether or not you get an employer match - if there is a match, make sure that if you consider reducing your contributions that you don't forgo any match $. If you're maxing out your contributions you're probably contributing at more than double the match rate so it's probably a moot point but worth considering.

At the end of the day, it all comes down to numbers. There are probably some calculators on line that can factor in the length and amount of the loan, the interest rate, you current contribution rate, your average earnings, company match etc. to help determine which will cost you less in the long run.

ETA: Uninformed people (I won't call you out by name) - a LOAN is NOT THE SAME as a WITHDRAWAL. There is no penalty for a loan. Not 10%, not 30%, not 40%. It is not ALWAYS a bad idea to take a 401(k) loan. Please don't answer questions if you have no idea what you're talking about. Obviously we're not all financial advisers but there is no point in responding with misinformation. I have worked in retirement plan administration for more than 10 years. The OP is in a very good position to take a 401(k) loan, it's just a matter of factoring in the small things like her tax bracket vs. interest rate and likely earnings to figure out whether the loan or reduced contributions are more advantageous.

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answers from Detroit on

Personally, I would reduce contributions rather than borrow against your 401K. The money that has been there has been gaining (hopefully) and you would lose out on that by taking money out now. Look at it this way - $5000 put in there 10 years ago will be worth much more in the future than putting in $10,000 now. So if you reduce what you are putting in now, you really haven't "lost" anything. I don't know if I am making sense or explaining it right, but it would seem to me that cutting back on contributions to fund your new house, rather than borrowing against it, will yield you more retirement funds in the long run.

ETA: This might be a better question for a CPA and/or professional financial adviser.

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answers from Chicago on

Ok, totally amending my original reply, as I wasn't done with it and wanted to check some details first.

The following links might be helpful to your decision-making. They all have slightly different viewpoints.

Article which says: You can do it, but be careful.

"8 Reasons to Never Borrow from your 401k" -

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answers from New York on

That 10% tax on withdrawl is in addition to paying the tax on it at your taxable rate. That 10% tax is a penalty for early withdrawl. So you would be paying 40% instead of just 10%.

When you take the loan for the purposing of buying a home you still will be paying back that loan through your employer but if your employment becomes no more then your loan becomes a withdrawl and is taxable.

The more sound approach would be to just save more and reduce the amount being contributed to the 401K.

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answers from Eugene on

Both the 401K and your house are investments. both have risk. So I'd do the math and see whether reducing contributions or taking a loan on the 401K results in more money toward your overall investment portfolio.

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answers from Dallas on


Sounds to me like you have a pretty good handle on your financial situation (very few people can say they are debt free these days), so I don't feel compelled to lecture you about the evils of debt. I'll just answer what you asked. :)

My opinion is that it would depend on the amount you are looking to borrow and how confident you feel in your husband keeping his job until it is paid off.

Reason being is like others have said if your husband were to lose his job, voluntary or otherwise, before the loan was paid back then that would be taxed as income, as well as be subject to early withdrawal penalty. If you are comfortable taking that risk, then you would essentially be borrowing from yourself and paying yourself back WITH interest.

It's really a numbers game that you have to determine based on your specific situation. Advice could be different for different situations. Good Luck and congrats on the new addition!

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answers from Norfolk on

The way I've heard it, never never NEVER take a loan from your 401k.
The pay back process is very painful.
The few people I know who've done it regretted doing it.
Reducing your contributions for awhile would be the better way.
If you have 100k n your current house, would an equity loan help you?

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answers from St. Louis on

pretty much I feel anytime you hit your 401k, you're stealing from your future. + you pay penalties.

I vote for the loan. :)

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answers from Chicago on

You got pretty good response. Take the loan, as people suggest, you are paying yrself back that helps. Even in case of Job switch like I did - you transfer over the balance and get loan and paythe difference to first company. You might have to pay little from your pocket, but wont be much. Especially with 9 month extra coming in you are rock solid. Dont reduce contribution, you miss out on tax break like your hubbty said.

I am also a financial advisor you are thinking in right direction.

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answers from Chicago on

Everyone has a case by case situation. In your case it seems as if taking the loan against the 401k is your best best.

Another thing to consider is talking to a financial advisor. When we were trying to calculate a big decision we spoke to our advisor about our finances first. He assured me we were *safe*. He showed us if we didn't contribute any more to any of our investments we would retire at x number of dollars based on what we currently had. That assurance made our decision much more safe for me.

Soooo much depends on how old you are, how much you have invested, how safe your investments are, how secure your husbands company is, etc etc etc

Oh something else is if your husband is possible looking at another job, whether he gets fired or he gets another job offer, or he likes to apply just to see.

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answers from Chicago on

Are you talking about borrowing against it or taking out actual money? If you borrow against it and you are permitted to do so and can afford paying it back, then that's one idea. On the other hand I actually took money out of the 401 K and ended up paying huge amounts in taxes.



answers from Washington DC on

I would check and see if there were penalties for early withdraw. Found this article from 2010. Not sure if general rules have changed.

Could you maybe cut the contributions by 25%?

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