Many retirement accounts such as 401K’s provide a loan option which allows individuals to essentially borrow from themselves. Taking a loan against your 401K does have some downside. First, if you change jobs you would have to pay back that money within 60 days or the amount of the loan outstanding would be treated as a distribution to you. This would be taxed as regular income and may also be subject to a 10% penalty based on your age.
Secondly, you will lose the earning power of that money. You may be saving the interest on what a loan would cost you, but you are also depleting the amount of money you have to invest. If you were able to invest and earn 10 to 12% on these funds, you would be losing a pile of money by taking a loan from your account.
On the subject of borrowing to buy a car, I have to tell you that my view on this has really changed over the years. When I was younger I tended to support the idea that borrowing to buy a car would be sensible so that a person could obtain a good, reliable, vehicle. I have learned through my own experience that there are plenty of great cars available for $4,000 or less in the used car market. No, I am not talking about rusted out clunkers, but nice running and looking vehicles. I will be writing soon about some simple steps to check out a used car to be sure it is in good mechanical condition.
In recent years while working as a mortgage broker, I was shocked to see how many families were unable to purchase a home due to auto loans. It was a regular occurence to have families with modest incomes paying nearly a $1,000 per month in car payments. Buying a good used car and paying cash seems like the only way to go with car prices going higher and higher.
So, on this particular question I am really going to advise you not to take the loan on your 401K to purchase a new model vehicle. If you have no money to work with, I would borrow up to $4,000 from the account and buy a used vehicle and pay the money back to your 401K within 6 months.
Prior to my financial collapse in 2002, I had owned several new cars over the years including Corvettes and Cadillacs (all with loans). Today, I drive a 2002 Ford Escape and it gets me where I need to go. I keep it clean and change the oil about every six weeks. My Ford has 167,000 miles on it. I have no payment and I love it. Every time I start it up I think about the fact that I don’t have an upcoming payment due. I have truly been converted to the buy a used car for cash philosophy.
Agree or disagree, click on comments below.
My main website is www.ChristianMoney.com
James L. Paris
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