While it’s never a good idea to borrow from your company-sponsored 401(k), using it to pay down a mortgage is as good a reason as it gets. While your 401(k) makes a good investment for your future, so does having little or no house payments. If you’re upside down on your mortgage -- owing more than the house is worth -- relying on your 401(k) may be a mistake unless you’re sure you can pay the money back on short notice. You can only borrow from your 401(k) if you work for the company sponsoring the fund, and borrowing is the only way you can gain access to the money while you’re still employed.
Borrowing the Money
Notify your employer’s human resources department that you wish to borrow from your 401(k). That department will notify the plan administrator, the firm that actually runs and invests your 401(k) for you. You can also call your plan administrator directly to finalize the loan, which doesn't require a credit check. You can borrow up to half of your 401(k) balance, to a maximum of $50,000. You don’t need to tell human resources or your plan administrator why you need to borrow the money, but you need to give your plan .
Because it’s a loan, any money your borrow is tax free. However, loans are paid back after taxes are withheld, unlike your regular contributions to your plan, so you're really paying taxes twice on a loan.
Paying the Loan Back
Tapping into your 401(k) is effectively an interest-free loan because you're basically borrowing from, and paying any interest to, yourself. However, the money must be paid back, and you should try to have the payments automatically deducted from your paycheck. You have up to five years to pay the loan back. If you leave that job before you pay it back, the company has the right to demand repayment within 60 days -- unless you want to pay at least 30 percent in taxes and early-withdrawal penalties for pulling the money out.
Financial expers say dipping into your 401(k) for any reason is a dumb move, as the reduced balance will affect any growth and matching funds. If you do choose to borrow, find out when the company pays its annual match and borrow from your 401(k) after the money is safely deposited into your account. Try to pay the loan back well before the next round of matching payments so you don't short yourself on your employer's matching funds. While the loan is out, you might not be able to contribute money to build your 401(k).
- Internal Revenue Service: Loan Limits Apply To All Plans
- CNN Money: Paying Off Debt With a 401(k) Loan
- Bankrate.com: Pay Off Second Mortgage With a 401(k) loan? No!
- Nolo.com: Should I Borrow From My 401(k) To Pay Off Debt?
- 401(k) Calculator: Everything You Need To Know About Borrowing Against Your 401(k)
Al Bondigas is an award-winning newspaperman who started writing professionally in 1985. His print credits include the "Mohave Valley Daily News" and "The Mohave County Standard." Bondigas studied journalism at San Bernardino Valley College in California.