Clark Howard's Simple Rule for 401(k) Loans: Don't Do It, Even If Rates Look Good

A 401(k) loan at 6.75% used to pay down a 6.5% mortgage creates a guaranteed rate gap of 0.25 percentage points before any fees. Loan setup charges typically widen the difference further. While the loan is outstanding, the withdrawn retirement funds stop compounding in the market. Repayment comes from after-tax income, but the sidelined balance misses dividends, reinvestment, and market gains during the repayment period. A scenario with $40,000 borrowed at 7% for five years shows the opportunity cost can grow substantially by retirement. Leaving an employer with an outstanding 401(k) loan adds a job-loss risk that can create serious consequences.

"When you pull $40,000 from a 401(k) as a loan, that $40,000 stops being invested in the market. You repay yourself with interest using after-tax payroll dollars, but the balance you removed misses every dividend, reinvestment, and market gain during repayment. Howard framed it cleanly: "Your 401(k), look at it and look what the compounding effect is over time. And it grows tax-free if you're in the Roth version of the 401(k). It grows tax-free. And when you spend it later, it is tax-free.""

"Run a plausible scenario. A 40-year-old borrows $40,000 against a 401(k) earning 7% annually and takes five years to repay it. The sidelined dollars would have grown to roughly $56,000 had they stayed invested. By retirement at 65, that $56,000 compounding at 7% for another 20 years lands north of $200,000. That is the real cost of using retirement money to shave 0.25% off a mortgage rate."

"There is a second risk Howard's caution rests on, and it has real teeth. If you leave your employer with a 401(k) loan outstanding, the unpaid balance is typ"

Read at 24/7 Wall St.