Pros and Cons of Tapping into Your 401K to Avoid Foreclosure

Foreclosure has become a crisis in America and many homeowners are desperately trying to find solutions to prevent foreclosure. More and more of them, if they haven’t already, are thinking about tapping into their 401K’s or IRA’s to avoid foreclosure.

When the housing market was up and the interest rates were at a historical low, there was a refinance frenzy taking place. Most of these mortgages were refinanced with an adjustable rate mortgage (ARM) and when there mortgage increased, homeowners were unable to pay the additional amount. When the housing market plummeted, not only did people lose jobs, but many homeowners could not even sell their homes to get out of foreclosure.

No matter what the situation, if you are one of the many homeowners facing foreclosure and your are thinking about using retirement savings, check out these “pros” and “cons” on using your 401K or IRA to avoid foreclosure.

Pros to using your 401K or IRA

Make sure to give this a lot of thought before using your retirement to bail you out. It still can be a good solution to avoiding foreclosure.

  • It is easy to get a loan or cash withdrawal from your 401K or IRA
  • Have up to 60 months to pay it back
  • No credit check
  • It is your money
  • The loan payment is deducted from your paycheck.
  • You can get up to 50% of your retirement money or $50,000 which ever is less
  • If you get a loan and as long as you do not default on your payments, you will not have to pay any penalties.
  • You can also be eligible for a hardship distribution, but will have to pay income tax on the money.
  • If you are 591/2 you can make a cash withdrawal without a 10% penalty, but you will still have to pay income tax on the money.

Cons to using your 401K or IRA

This can also be bad solution if you are getting close to retiring. You don’t want to dip in the money you will need to live on.

  • You have to pay it back with interest
  • If you lose your job and default on the loan, you will have to pay income tax and IRS will assess a 10% penalty on all of the money you borrowed.
  • If you qualify for a hardship distribution you will still have to pay income tax on the money
  • If you decide to just take a cash withdrawal, you will have to pay IRS the 10% penalty along with income tax.
  • You fund your 401K with pre-tax money you have to pay it back with post-tax money.
  • When you get ready to withdraw the money for retirement it will be taxed, again.
  • While you have the money out, you will lose on any interest or dividends it could have made.

If tapping into your 401K or IRA to avoid foreclosure is your last resort, than taking out a loan from your 401k would be the better choice. At least you will be putting the money back with interest. Make sure this solution will alleviate the problem and not add to it. You don’t want to be in the exact same situation six months from now.

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Posted on Jan 27, 2010