You’ve probably heard it said a thousand times to leave your retirement savings alone. After all, the longer you let your retirement savings sit undisturbed and unspent, the greater your chances of growing it to a sizable nest egg, especially since missing just five of the market’s best days could leave you with half the amount you would have otherwise had — according to a study by Fidelity.
But a 401(k) loan is an interesting animal. This is a loan you essentially take against yourself, meaning what you borrow you’ll eventually pay back. And, yes, while there is an interest rate attached to your loan, it’s an interest payment that goes back into your 401(k). For homeowners looking for ways to finance renovations projects, that raises a good question — could it be savvy to use your 401(k) to finance home renovations, especially if your other options are high-interest debt?
It’s a tricky question. But let’s take a closer look and see if it’s worth borrowing money from your retirement savings to renovate your home.
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Do it if the renovations are necessary
A 401(k) loan might be worth it if the renovation is urgently needed. For example, if you need to remodel your home for wheelchair accessibility — installing ramps, customizing spaces with handrails, or building a lift — your 401(k) could give you a way to avoid personal loans and credit cards. Likewise, if your home has a safety hazard that home insurance does not cover, your 401(k) could help you afford projects without going into debt.
As I’ll discuss below, a 0% APR credit card could also give you a low-cost borrowing option to do these renovations. But depending on your circumstances, your 401(k) could be a viable choice.
It might be worth it if it means boosting your equity before a home sale
Targeting renovations that will boost your home’s value could mean selling your home for a higher price. In this case, a 401(k) loan could be worth it. You could take the proceeds from your sale to pay off the loan, effectively returning your 401(k) money back to its rightful place.
But this may not work as smoothly as you might think. For one, you have to target renovations that actually return what you pay for them. The list of home renovations that give you a 100% return on investment are surprisingly few and are usually limited to projects that boost curbside appeal, like replacing your front door or adding new siding. Renovating your kitchen or bathroom could give you a good return, but certain high-scale projects may leave you spending more out of pocket than you get in resale value.
Weigh the cons carefully before you proceed
Borrowing from your 401(k) does have consequences, not the least of which is losing potential earnings from your investments. But even more so than opportunity costs, taking out a 401(k) loan does have some risks, including:
- Owing taxes and penalties: Even though you’re paying money to yourself, you’re still expected to make payments on time. If you fail to pay back what you borrow, the IRS will treat it as an income distribution. You’ll have to pay ordinary income taxes, and you may be subject to a 10% withdrawal penalty if you were younger than 59½ when you borrowed the money.
- Losing your job: Typically, you have five years to pay back what you borrow. But if you lose your job before you pay the loan, you’ll owe the remaining balance by Tax Day for that year’s taxes.
In addition to these risks, your 401(k) provider may not even allow 401(k) loans. Check in with your provider to see if it’s a possibility and, if it is, make sure the fees are worth borrowing the amount you’re interested in withdrawing.
Consider a 0% APR credit card instead
If you can’t borrow money from your 401(k), or you don’t want to risk missing the market’s best days, you could fund your home renovation with a 0% APR credit card instead.
These cards have a promotional 0% interest period during which you won’t pay interest on what you borrow. This gives you time to pay off your balance without risking going into credit card debt. Just be careful — once the 0% APR promotional period ends, you’ll start paying interest at a higher rate. As long as you can pay off what you borrow before the period ends, these cards could give you a low-cost way to renovate your home.