I have a problem that I hope you can help me with. I am in my mid 40’s and about two years ago I got divorced. We were able to resolve everything without any fights or drama. At the time of the divorce I wanted to keep our house so my wife, who handled all our finances, recommended that I take a loan from my 401(K) Plan to pay her off on the house, which I did. Earlier this year, I quit my job and got a new job. My employer was not happy because the new job is with a competitor. My problem is my old company just notified me that my loan is due in full. I don’t have the money to repay the loan. My first question is can they do that? I think that they’re punishing me for going to a competitor. My second question is what happens if I don’t repay the loan; what can they do? Also, any suggestions that you may have in how to deal with this situation would be helpful.
Whether your ex-employer is being vindictive or not is relatively immaterial. When you take a 401(k) Plan, part of the terms of that loan is that the loan becomes due generally 60 to 90 days after you leave your employment. Therefore, the company is well within their rights to demand payment. Although 401(k) Plans are easy to borrow from, one of the downsides is that loans become due once you leave the employer.
With regard to your second question, if you do not repay the loan, then what the employer does is treat it as a distribution. What that means is that you are going to pay taxes on that money. For example, if you borrowed $25,000 from your 401(k) and you didn’t repay the $25,000, that $25,000 would be taxed to you as ordinary income. In addition, because you are under 59½, this money is treated as an early distribution and thus, the IRS, in addition to the taxes, will assess you a 10 percent penalty for early distribution.
In reviewing your situation, since you don’t have the resources to repay the loan, one avenue I would explore would be a home equity loan. A home-equity loan would allow you to tap into the equity on your home at a relatively low cost. Although, interest rates have gone up and I anticipate they will continue to rise, home-equity loans are still relatively affordable. In addition, the interest you pay on your home-equity loan is tax deductible. Therefore, my advice is that in order to avoid the 10 percent penalty and having to recognize additional income, consider a home equity loan.
Just like anytime you borrow money, it does pay to shop home-equity loans around. Not all companies have the same rates or fees. In addition to checking with your current mortgage company, it also pays to check with a credit union you may belong to or even to shop rates online with reputable companies. You may be surprised how much money you could save by shopping around.
In obtaining a home-equity loan one thing to keep in mind is that we are in a period of rising interest rates. In most home-equity loans the interest rate is adjustable which means that as interest rates rise, so will the interest you pay on your home-equity loan.
Generally, I’m not a fan of borrowing money one one’s home; however, in this situation it makes sense. When someone asks me about borrowing on their home to take a vacation to buy a new big-screen TV, I’m generally not in favor or that. However, if someone borrows on their home to pay off another debut such as the one at hand or a high interest rate charge card, I’m generally in favor of that. I always believe that whenever you borrow money you need to use caution and make sure that the money you’re borrowing is not going to be frivolously spent.
If you would like Rick to respond to your questions, please email Rick at email@example.com