Home Equity vs. 401(k): Strategic Solutions for Needed Cash
Faced with a financial crunch? Before tapping into your 401(k), consider the power of your home equity. Our latest article dives deep into the strategic battle between these two cash sources, revealing why your home might be your secret financial weapon. Discover how leveraging home equity can preserve your retirement nest egg, potentially offer tax benefits, and provide more flexibility than a 401(k) loan. But it's not all rosy - we'll also uncover the risks and considerations you need to weigh.
This blog is for educational purposes only, not an offer of credit or advertisement for current loan terms. It does not provide legal advice. Refer to our loan web pages or consult professional advisors for specific information.
There are several reasons why homeowners might need a significant amount of funds: debt, repairs, investments, etc.
Two ways you might secure the cash needed are:
- Taking a loan from your 401(k)
- Leveraging the equity in your home
While both have their merits, this article will explain why using home equity is often the better choice.
We’ll compare these options, highlight their differences, and demonstrate why Home Equity Loans are superior.
Start your application with MIDFLORIDA Credit Union.
Borrowing from your 401(k): The basics
A 401(k) loan lets someone borrow money from their retirement savings account (some 401k plans do not permit borrowing).
A person can typically borrow up to half their vested balance but only to a maximum of $50,000.
The loan must be repaid with interest, usually within five years (longer terms may be available if the loan is used toward purchasing a primary residence). However, if your employment terminates you may have to repay the loan within 90 days.
For more information, consult your 401k Plan Representative.
Using home equity: The basics
Your equity is calculated by taking the market value of your home and subtracting the outstanding mortgage balance.
Homeowners typically access their home equity in one of two ways:
- A Home Equity Loan
- A home equity line of credit (HELOC)
Both options use your home as collateral, but the main differences are:
- A Home Equity Loan results in a lump sum payment with fixed interest rates.
- A HELOC typically involves a revolving line of credit with variable rates.
Why home equity is often the better choice to tap into for cash
Preservation of retirement savings
One of the most significant advantages of using home equity over borrowing from a 401(k) is that it preserves your retirement savings.
When you take a loan from your 401(k), you reduce the amount of money invested for your future.
This could have long-term implications, as the borrowed amount is no longer compounding and growing tax-deferred.
Using home equity instead leaves your retirement savings untouched, allowing them to continue growing.
Lower interest rates
Home Equity Loans and HELOCs typically offer lower interest rates than 401(k) loans—because Home Equity Loans are secured by your home, reducing the lender’s risk.
In contrast, 401(k) loans are secured by your retirement savings, which may provide lenders with lower security.
Lower interest rates are often preferred because they result in lower monthly payments and less interest paid over the life of the loan.
Tax benefits
The interest you've paid on Home Equity Loans and HELOCs may be tax-deductible if the loan is used for home improvements1.
This potential tax benefit can make borrowing against your home equity more cost-effective than a 401(k) loan.
Note: Consult a tax advisor to understand your situation and eligibility for this deduction.
Flexibility and larger loan amounts
Home Equity Loans and HELOCs could offer larger loan amounts than 401(k) loans.
This can be particularly beneficial if you need a significant amount of money for large expenses such as:
Additionally, HELOCs provide flexibility, allowing you to borrow and repay funds as needed—similar to a credit card, which can be advantageous for ongoing expenses.
The difference between borrowing from 401(k) vs. home equity
Collateral
The primary difference between these two options is the type of collateral used.
- A 401(k) loan is secured by your retirement savings
- A Home Equity Loan or HELOC is secured by your home
On average, a person’s home equity can give you access to more funds, depending on your financial snapshot.
Impact on retirement savings
Borrowing from your 401(k) can significantly impact your retirement savings.
The borrowed amount is no longer invested and growing tax-deferred, which can reduce the overall balance of your retirement account.
In contrast, using home equity does not affect your retirement savings or the growth in home value, allowing them to continue growing.
Penalties
401(k) loans typically have shorter repayment terms, usually around five years, and must be repaid with interest.
If you fail to repay the loan or leave employment before the loan is repaid, the outstanding balance may also be considered a taxable distribution. It could trigger early withdrawal penalties if you’re under 59½.
Considerations of home equity options
While Home Equity Loans offer several advantages, there are also some factors to consider.
Risk of foreclosure
Since your home is used as collateral, failing to repay a Home Equity Loan or HELOC can result in foreclosure.
Carefully evaluate that you can comfortably afford the monthly payments and that borrowing against your home equity will benefit your financial situation.
Closing costs and fees
Home Equity Loans and HELOCs often have closing costs and fees similar to those associated with a mortgage, which should be factored into your decision-making process.
These can include:
● Appraisal fees
● Origination fees
● Other expenses
However, it's worth noting that some financial institutions, including MIDFLORIDA Credit Union, offer promotions that can significantly reduce or eliminate these costs. For example, MIDFLORIDA currently offers a "No Closing Costs" option for eligible loans under $400,000 on primary residences.² This can make Home Equity Loans more attractive for those looking to avoid upfront expenses.
Long-term commitment
Home Equity Loans and HELOCs are long-term commitments, typically lasting 5 to 20 years.
Consider whether you’re prepared for this financial obligation over the long term and plan to manage your finances effectively during this period.
401(k) vs. home equity for borrowing cash
By weighing the benefits and considerations of borrowing from your 401(k) and using home equity, you can decide which option is best for your financial needs.
With the potential for lower interest rates, tax benefits, and larger loan amounts, a Home Equity Loan might be the right choice to help you achieve financial stability.
MIDFLORIDA has many home equity solutions
If you’re considering using home equity to meet your financial needs, MIDFLORIDA can help.
With competitive interest rates, flexible terms, and personalized service, we can guide you through the process and help you make the best financial decision for your situation.
Start your application with MIDFLORIDA today and take the first step toward achieving your financial goals.
Further Reading Recommendations
1If the extension of credit exceeds the fair market value of the property, the interest on the portion of the credit extension that is greater than the fair market value of the property is not tax deductible for federal income tax purposes. Consult a tax adviser for further information.
2 “No Closing Costs” applies to eligible loan under $400,000 on primary residence on platted lot less than ½ acre with a combined loan to value (CLTV) of 80% or less. Does not apply to purchase transactions. Appraisal, survey, title policy and other closing costs at borrower’s expense may be required on other loans. Costs subject to recapture within 36 months. Not all homes will qualify to be mortgaged for more than their original purchase price.