As household budgets get pinched and credit markets tighten, a growing number of Americans are making “hardship withdrawals” from their 401(k) plans. 

One major fund group cites a 15 percent increase in activity from this time last year for various reasons including staving off foreclosure and medical emergency.

However, 401(k) loans should only be made with careful consideration.

On the positive side, 401(k) loans don’t require a credit check.  This is helpful feature for people deep in debt, and who may have missed a payment or two to their creditors.  With no credit score requirement, a poor payment history won’t disqualify a plan participant.

In addition, most 401(k) loans can be arranged with just a phone call and a small stack of paperwork.  There’s no “qualification process” like applying for a credit card or a mortgage.  Money can be available, therefore, in as little as a day.

But there are negatives to 401(k) loans and the biggest one relates to taxation. 

If you take a 401(k) loan and can’t repay according to its terms, the IRS taxes the loan as ordinary income and slaps on a 10 percent penalty if you’re under 59 1/2.  That can be very costly for a lot of people. 

But, even if you do repay the loan on time, it’s still gets expensive.  This is because 401(k) loan repayments are subject to double-taxation. 

The first taxation occurs when the loan is repaid because the payback is made with post-tax paycheck dollars.  A person in the 25% tax bracket, for example, would need a $1,333 paycheck to repay a $1,000 loan — the missing $333 goes to taxes.

And the second taxation occurs at retirement when the funds are finally withdrawn.  The IRS taxes that money as ordinary income.

Now, this isn’t to say that taking a loan against your 401(k) is bad, it just may not be the best possible route for a person in trouble.  Especially because of the costs.  If you’re planning to withdraw from your 401(k) for hardship, be sure to talk with a qualified financial professional first. 

If you’d like a referral to a trusted professional, call or email us anytime.

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Monday, after the House of Representatives defeated the Emergency Economic Stabilization Bill of 2008, the stock market fell in historic fashion.The Dow Jones Industrial Average closed down 777.68 points, its largest one-day point loss ever.

By Tuesday, however, optimism had returned to Wall Street.

Assuming that the bill would pass in some form, investors poured back into the stock market, driving prices up.  Again, in historic fashion — Tuesday’s gains were the third-largest on record.

The stock market activity is highly relevant to mortgage rates right now because when investors flee the stock market, they’re often parking their money in bonds.

In general, that causes mortgage rates to fall.

But, by contrast, when investors regain their appetite for stocks, as they did Tuesday, they move back into the market, “unparking” their bond money.  This causes mortgage rates to rise.

Both Monday’s and Tuesday’s dramatic action points to the speed at which market conditions can change, taking mortgage rates with them.  Wall Street’s back-and-forth mentality has been one of the reasons why mortgage rates have bounced so wildly since July.

We can’t predict if rates will fall or rise going forward, but if the stock market is any sort of a clue, in whichever direction rates go, they’re going to go there quickly.

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