When you're in a bind, the last thing you want to hear is a list of reasons why you shouldn't borrow the money you need. Often, however, that's exactly what you'll hear about taking out a loan against your retirement plan at work.
It's easy for financial planning experts to tell you that borrowing from your 401(k) isn't an ideal thing to do. But when times are tight, even people who are pretty smart with their money often have to choose between unattractive options. And compared with some other ways to get the money you need, you can do a lot worse than 401(k) loans. Consider:
Decent rates. Credit card advances can cost you 20% or more. Payday loan outfits such as Advance America
(NYSE:AEA)and Cash America (NYSE:CSH)can leave you with an even bigger bill, especially after you consider fees and other charges. But many 401(k) loans are made at prime plus 1%, which is currently 8.75%.
- No extra collateral. With other loans, you often have to put up assets to secure the loan. Whether it's your house, your car, or another asset, you may not be excited about putting your possessions on the line for a loan. With a 401(k) loan, on the other hand, the collateral -- your plan balance -- already belongs to you.
- Flexible terms. Many plans let you take loans for up to five years. Even longer periods are available on loans to buy a home -- as long as 15 years.
- No hassles. Compared with other loans, getting a 401(k) loan is simple. There's much less paperwork, and you don't have to worry about having bad credit or meeting lender qualifications.
On the other hand, you've probably already heard some of the objections to borrowing against your 401(k). If you can't pay back your loan, you'll be treated as though you'd withdrawn the money from your 401(k) -- with all the taxes and penalties that apply. What's more, if you lose your job or decide to switch jobs, you have to pay back your loan right away. And as long as your loan is outstanding, you'll miss out on the returns you would've earned if you'd been invested in stocks.
Yet it shouldn't be news to anyone that you have to be careful when you borrow money. If you're not sure when or how you'll ever pay back your loan, borrowing from a 401(k) isn't the best choice. Then again, you won't lose your house -- which is more than Washington Mutual
So if you're facing a temporary setback and need a short-term solution, a 401(k) loan may not be as bad as some experts think -- and a lot better than your alternatives.
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Fool contributor Dan Caplinger has avoided having to take out a 401(k) loan so far. He doesn't own shares of the companies mentioned in this article. Washington Mutual is an Income Investor recommendation. The Fool's disclosure policy won't turn you down.