In this article on 401(K) loan basics, we will tell you all about the pros and cons of 401(K) loans. The information will help you decide whether you should take the loan or not.

Borrowing from your 401(K)
If you know the 401(K) loan basics you would have understood that a 401(K) loan is essentially a loan you are taking from yourself. You repay the loan with interest back to your account. This loan is given at a good interest rate, and there is no credit score requirements to get the loan.

The above information makes it seem that it is highly advantageous to get a 401(K) loan. It is not so simple. We discuss the pros and cons of taking a 401(K) loan to help you decide if you should use this facility.

Pros of a 401(K) loan

• A 401(K) loan is available from your own funds and you can take a loan for up to $50,000.
• You can repay the loan within five years or even earlier and at an interest rate that is good compared to market rates.
• You can get this loan even if you don’t have a good credit score and the interest rate does not depend upon the credit score.
• It is a good idea if you need a short-term loan quickly and are confident of being able to repay it fast.
• You can use it to clear a credit card debt or an outstanding loan. You can take a 401(K) loan, clear your pending debts, and then pay the 401(K) loan at a lesser rate.
• Borrowing against a 401(K) account is a good idea to fund educational expenses.

Cons of a 401(K) loan

• You are paying interest back to yourself but this interest is taxable as per law. You will again be taxed on this amount when you withdraw it after retirement.
• Your employer may not allow you to continue contributing to your 401 (K) loan account when you have a loan pending on it. This will reduce your overall contribution and decrease the amount you get when you retire.
• If you lose your job, you need to repay the loan amount within a year. If you fail to do so, a 10% penalty is levied on the balance amount. The amount also becomes taxable.
• Some 401(K) plans don’t allow loans. If you have a 401(K) from an old job, you cannot take a loan on it.

Should you take it?
A 401(K) loan should be taken only if you have no other option. It should not be treated like a treasure trove to be raided. The tax and penalty component if you default should make you handle this carefully. It is a good idea as a short-term loan or to cover educational expenses. Take this loan only if you are confident you can repay it quickly and won’t lose your job in-between.

The 401(K) loan basics article presented the benefits and disadvantages of taking a 401(K) loan. The information on when you should take a 401(K) loan will help you decide if you should really take a loan or not.