The truth about borrowing from your 401(k) for home improvements. As a homeowner, there’s no better way to add value to your property than through renovations. Whether you’re improving existing rooms or adding new ones, the added comfort and curb appeal is worth the effort. However, funding an addition to your home is costly, and finding the money to pay for the project can be challenging.
A quick way for homeowners to obtain the needed funds is to borrow from a 401(k) or withdraw from an IRA. Taking money out of a 401(k) for home repairs is a convenient way for homeowners to fund a new home renovation project. Here are some risks and benefits of using retirement assets for home improvements.
The cost of using your 401(k) for home improvements
There are a few benefits to using your IRA or 401(k) instead of a personal loan to pay for home repairs and renovations, as well as some added risks. When borrowing from your 401(k), you’re ultimately borrowing from yourself and paying yourself back at lower interest rates than a credit card. Still, borrowing from a 401(k) significantly reduces your retirement savings. Employees who lose their job must also pay back the entirety of the loan within 30 to 60 days of termination or risk additional penalties.
How much can I borrow from my 401(k)?
Taking a loan from a 401(k) permits you to borrow up to 50% of the value of your 401(k), a maximum of $50,000 within 12 months. Homeowners with over $50,000 in renovation projects must consider finding additional funding sources besides a 401(k) loan. If you’ve previously borrowed from your 401(k), the amount you can borrow with a new loan is reduced by the outstanding previous year amount. Someone who borrowed $20,000 from their 401(k) last year and paid it off one month ago will only be able to borrow $30,000 from a new 401(k) loan.
Paying back a 401(k) loan
The cost of a 401(k) loan includes the principal amount and the interest rate. Any amount borrowed from your 401(k) must be paid back within five years and will be deducted directly from your paycheck. Borrowers must understand that a 401(k) loan carries the implications of a smaller salary.
When borrowing from your 401(k), it’s essential to consider that some plans will not allow you to make contributions while paying the loan back. Sometimes, you will lose the opportunity to save for retirement and benefit from an employer’s matching contributions.
Consider alternatives to finance home renovations
While borrowing from your 401(k) may seem like a convenient way to fund home improvements, it also comes with a great deal of risk. A personal loan for home improvement could be a better option for your needs and allow for you to still have the funds you need for your golden years.
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