Although a 401(k) is intended to be a retirement plan to help you out once it comes time for you to retire, many people consider taking out a loan from their 401(k) in order to pay for a car, a child’s college education or another expense. Thankfully, it is possible to borrow from a 401(k) plan, but it is important to consider some things before you make the decision to borrow. Keep in mind of the following before you decide to take money out of your 401(k) to purchase a car.
Your Interest Rate
Since your 401(k) is a loan product, you will still have to pay interest, but the interest you will be paying is actually to yourself, as you will essentially be lending the money used to purchase a car to yourself. The interest rate on your 401(k) loan will be competitive, though, thankfully, even when compared with low interest rate loans for credit cards and the like. You can find out how much you need to retire at Suncorp today.
Your interest rate on your 401(k) loan will be the current prime rate with an additional one or two percentage points added to it. This is often a lot cheaper than other forms of credit, but you still have to keep in mind that there is an interest rate, nonetheless.
Your Credit Rating
Keep in mind that when borrowing from your 401(k) to buy a car you should take into account what your credit rating is. It will not affect whether you are able to borrow from your 401(k) plan, as you are borrowing this money from yourself, but it might not be the best choice if you have an excellent credit rating. If you have a high credit rating, you might want to consider a less-risky way of accessing funds to purchase a car.
On the other hand, if you don’t have a good credit rating, you might find that taking a loan from your 401(k) plan is an excellent option, as you don’t have to worry about being approved for a loan and you can get a lower interest rate than you would with other loan or credit options.
Your Job Security
This is probably the most important thing to consider if you are thinking about taking money out of your 401(k) plan to buy a car. If you take money out from your 401(k) early, you will have to pay income taxes on the money you’re taking out, and if you’re under 59 ½ years old, you will also have to pay additional penalty taxes. However, if you decide you are going to take out the money using a loan, which would be paid back through your payroll, you won’t have to pay taxes on the money immediately, even though you are paying the loan back using after-tax income.
It is important to keep in mind, though, that if you leave or lose your job, you will likely have to pay back the money you borrowed within a short amount of time (often 60 days). If you are not able to pay it all back within that time, you also have to pay taxes and penalties like you would if you simply took the money out of your 401(k).