Think Twice Before Borrowing From Your 401K For Debt Consolidation

One of the hottest topics that has been circulating around financial circles for the past few years has been debt consolidation. It is not surprising that this subject has maintained its high level of popularity. More people than ever are spending above and beyond their means, and are finding it very difficult to live from paycheck to paycheck. A debt consolidation loan, along with implementing a sensible budget, can help these individuals get back on solid financial ground. These loans enable a person to wrap all (or most) of their creditors into a single manageable payment. The hardest part of the whole consolidation process may be determining where you are going to obtain your loan. One option is for an individual to borrow money from his 401k plan. However, is this really the best alternative available?

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• No collateral is needed. Unlike some other forms of debt consolidation loans, borrowing from your 401k does not require any assets to be used as security.
• Interest goes to the borrower. When an individual pays back the loan, he is essentially paying the money to himself. This sure beats sending your money to a bank.
• Potentially large amounts. Many plans allow participants to borrow up to 50% of their total balance (not to exceed $50,000), which can often equate to large amounts of money.

• Loan is called due if you leave your job. This is a major drawback. If an individual is unable to repay the loan then they will be taxed and penalized as if they took an early withdrawal. At that point the money is gone from their retirement savings.
• Forfeit accrued interest. While the money is gone from the plan it is not able to accumulate interest. The interest you pay back into the account does not generally equal the amount that would have been gained in the market. This could add up to a significant amount in the long run.

For people who are willing to discipline their financial habits, a debt consolidation loan may be a perfect fit. The difficult task then becomes choosing the source to borrow the money. One option that many people consider is accessing money from their 401K. Although this option has several advantages it also has some major drawbacks. When an individual removes money he immediately begins to lose out on accrued interest and he risks loosing this portion of his retirement plan if he looses his job. Because of these serious disadvantages, 401ks should be looked upon as a last option.

Mark Cairney is a professional consultant with First American Debt Consolidation and Loans, a debt consolidation service specializing in financial education, credit counseling, and debt management services nationwide.