Surprising to me is how common borrowing is from 401(k) plans.
90 percent of 401(k) participants are in plans that offer a loan option. Within those plans, on average about 22 percent of eligible participants have a 401(k) loan outstanding at any given time. A much higher fraction, slightly less than half, use a 401(k) loan over the seven-year period from 2002 through 2008 that the authors study.
This has undoubtedly risen with the recession that’s been going on since 2008. Not only do more people have a greater need to tap into that 401k, the reduction in employer match makes contributing less attractive and possibly lessens the attraction of the 401k altogether. Plus, there is some school of thought that the 401(k) loan may be better than high credit card debt.
Is it better or worse to take out a 401k loan and pay yourself back interest or pay high interest to someone else? Do you risk a loan against your home with the housing market going down with no end in sight? Maybe even go to a credit card and pay 15, 18 or 20% interest. I know, it’s your retirement and you’ll need it. You do need to get there first and if you are carrying two mortgages and big high interest debt, it won’t matter what you have in the 401k.
So who takes out loans?
Loan utilization rates first rise and then fall with respect to age, tenure, compensation, and plan balances. They reach peaks for participants in their 40s, those with 10 to 20 years of tenure, those earning $40,000 to $60,000 per year, and those with plan balances between $20,000 and $30,000. For those who have a loan, the loan-balance-to-401(k)-balance ratio declines with age, tenure, compensation, and 401(k) plan balance.