When most people contribute to their 401(k) plans, they think about saving up for retirement. However, a few people also use this retirement account as a credit line to cover various expenses. You can take out a loan against a 401(k), but just because you can do something doesn't mean that you should.
A car owner currently has an auto loan with a 12.6% interest rate. Borrowing against the 401(k) plan only results in a 9.5% interest rate for a 36-month term. A lower interest rate will help the borrower save money. It may seem like a good move on the surface, but once he shared his situation with Reddit, a different picture emerged.
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Borrowing Against A 401(k) Plan Can Enable Bad Habits
Borrowing against a 401(k) can set you back since you'll have to pay a new debt. While the 401(k) can be used to get rid of a higher-interest auto loan, it can enable bad financial habits. Viewing debt as the solution to getting out of debt will result in more fees and interest accumulation. Relying on debt to get out of debt can also keep you in an endless cycle of interest payments.
If the car owner doesn't borrow against their 401(k) plan and doesn't like the high interest rates, they can find other ways to pay off the debt faster. Temporarily picking up a side hustle, asking for a raise, and looking for more promising career opportunities can boost your earnings and get you out of debt faster.
It's more comfortable and easier to take out an additional loan to pay off an auto loan. People take a similar approach when they default to personal loans to pay off credit card debt and then use a home equity loan to cover the personal loan in the future. Taking actions that increase your income will do you better in the long run than borrowing against a 401(k) plan.
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A Credit Card Balance Transfer May Work
If the car owner can pay off the debt quickly, a credit card balance transfer is another great option. Not every auto lender will let you use your credit card, but if you can pull it off, you can end up with 0% APR for the next 12 to 24 months, depending on your credit card.
This isn't completely free since credit cards charge a 3% to 5% fee for the transfer. For instance, if you owe $10,000 on your auto loan and put it on a balance transfer credit card, you can expect a $300 to $500 fee. Make sure you check your credit card's fees to see how much you'll be charged for the transfer.
The only downside with a credit card balance transfer is that these financial products are notorious for their high interest rates. Balance transfers are optimal for people who can pay off the debt quickly. The original poster was grateful for the idea and thanked the commenter who suggested it.
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Consider Lowering Your 401(k) Contributions
One commenter suggested that the Redditor temporarily reduce their 401(k) contributions to accelerate paying off the auto loan instead of borrowing against the 401(k) plan.
"Borrowing from retirement is a lot of risk and potentially very expensive. Conventional wisdom would be to leave it alone and separate it from any present-day financial decisions," the commenter suggested.
Some people responded by saying that this strategy will reduce the Redditor's long-term gains if the stock market has a strong year. Others recommended following this advice, but contributing up to the employer's match as a minimum.
It's also worth noting that some 401(k) providers prohibit you from making any additional contributions to your retirement account while you are paying off a 401(k) loan. If that rule is in place for the Redditor's provider, then it makes even less sense to borrow money against the 401(k) plan.
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