Home Equity Loan – Still A Better Idea Than A 401(k) Loan

Submitted By: Charles Essmeier

In a previous article, we have outlined several reasons why borrowing against a 401(K) account may be less favorable than using a home equity loan instead. The reasons include the fact that the interest on a 401(K) loan is not tax deductible, and that the borrower loses the ability for his or her investment to compound over time. If you have borrowed the money, it can’t earn interest and the cost over twenty or thirty years could be dear. In addition to those, there are other reasons why a home equity loan would be a better source of consolidation funds.

The 401(K) loan is tempting. There is no credit check, the interest rate is usually favorable, and you are paying the interest back to yourself. The additional disadvantages are considerable, though. The money you borrow from your retirement account was money invested before taxes. The money you pay back is after-tax money, effectively increasing the amount that has to be paid back. Worse, should you lose your job, the 401(K) loan must be paid back immediately, in full. Should this not be possible, the loan is treated as a distribution, requiring the payment of a 10% penalty in addition to state and Federal taxes. With the job market still rather volatile, the additional risk of borrowing against a retirement account is substantial.

Borrowing against a tax-deferred retirement fund is rarely a good debt consolidation option. The tax disadvantages, the threat of penalties and immediate repayment and loss of compounding generally make such a loan a bad idea. Those with existing student loans should probably keep them; the interest is tax deductible and the rate is still lower than with most other consumer loans. For most anyone else, a home equity loan would be a better choice, offering deductible interest, fewer risks, and a fixed repayment schedule. Anyone considering a consolidation loan should consider all of these options carefully, as the cost of choosing poorly could be great.

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