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Is Getting a 401(k) Loan a Good Idea?

Don’t do it!

That’s the conventional wisdom about taking out a 401(k) loan. And as someone who took out one, left her job and found herself shelling out big bucks in taxes and penalties, I’m not about to argue with conventional wisdom.

However, people stretched financially thin may think otherwise. They may see their 401(k) account as a tempting source of cash. To help those of you thinking about dipping into your account, we want to take a moment to review what you need to know about these loans. I also contacted two Certified Financial Planners so you wouldn’t have to take my word for it.

I fully expected both planners to say 401(k) loans are nothing but bad news, and certainly, they both expressed extreme concern about people dipping into their retirement savings. But I was also surprised to hear that a 401(k) loan may make sense in some limited situations. Before we get to those, let’s start with the basics of 401(k) loans.

Basics of 401(k) loans

Named after a section of the tax code, traditional 401(k) plans allow you to put money aside, tax-free, for retirement. After a few years of regular contributions, these plans can carry a nice balance, which may start to look like a handy cash cow.

While there is no requirement that 401(k) plans allow loans, many do. Under IRS rules, those that do allow loans can let participants take out up to 50 percent of their vested account balance, or $50,000, whichever is less. Typically, these loans are paid back over a maximum of five years, although, in some cases, a longer payback period may be arranged. On occasion, the IRS issues special rules, such as after hurricanes Katrina, Rita and Wilma when those affected were allowed to take loans for their entire vested balance.

Loans from 401(k) accounts do charge an interest rate, but that money is paid back into the plan. This is one reason they may appeal to some workers. Rather than paying interest to a bank or other lender, the worker keeps the interest to pad their retirement account. In addition, repayments are made via a payroll deduction, which makes them convenient, another bonus for some workers.

Why they aren’t such a hot idea

Despite being an apparent source of easy cash, some finance experts say you should be keeping your hands off your 401(k).

“Your 401(k) is not a savings account,” says Mark Vandevelde, a CFP and wealth partner with Hefty Wealth Partners in Auburn, Ind. “It is money that should be set aside for long-term goals and never to be touched, in my humble opinion.”

As Vandevelde sees it, there are three problems with 401(k) loans:

  1. Lost investment gains that can reduce your fund balance at retirement.
  2. The risk of defaulting on the loan, which could result in taxes and a penalty.
  3. The chance you may reduce your 401(k) contributions to afford the loan repayment amount, which again could affect your fund balance at retirement.

“It’s not free money,” Vandevelde says. “You have to pay it back with regular payroll deductions. Many people end up reducing their actual 401(k) contributions to compensate for the amount they are having to pay back and, therefore, they actually aren’t saving as much.”

On its website, Principal Financial Group has an example of how this may play out. A 35-year-old who takes out a $5,000 loan and pays it back over five years may find himself with $52,000 less at age 65. The calculation assumes a $150 per-paycheck contribution that is decreased by $44 to accommodate the loan repayment.

Keith Klein, a CFP and owner of Turning Pointe Wealth Management in Phoenix, agrees with Vandevelde that a 401(k) loan shouldn’t be your first choice for cash.

“The key to remember is when you take money out, it has to be paid back in five years,” Klein says. “If you default, that money will be considered income, and you’ll have to pay taxes plus a 10 percent penalty.”

Plus, a lot can happen in five years, and if you find yourself taking a new job opportunity, you’d better be ready to pay up.

“A lot of people don’t realize what happens when you leave [or] get fired from your job and you have an outstanding 401(k) loan,” Vandevelde says. “It becomes immediately due and has to be paid in full. If you cannot pay it back, the remaining balance is considered a distribution and is subject to tax and a 10 percent penalty if [you’re] under age 59½.”

When a 401(k) loan might make sense

Despite the financial perils associated with a 401(k) loan, Klein says there may be times when it makes sense to take one out.

“Now, I’m not recommending you take loans out,” he says, “but there are circumstances when life doesn’t go perfectly.”

For example, an older worker who is losing a job may find taking out a loan and letting it default could be a better option than paying their bills with the credit card until they find other employment or are old enough to claim Social Security. While the money will become taxable income, the 10 percent penalty no longer applies once an individual turns 59½.

Divorce or disability could be other scenarios in which a 401(k) loan may be a better way to bridge an income gap in an emergency situation. Still, Klein says it’s not an ideal option. “Having a [cash] reserve is always the best answer,” he notes.

Both Vandevelde and Klein say that, unfortunately, far too many people rush into a 401(k) loan, or they use them for purchases such as vacations, cars or even big screen TVs. For those sorts of purchases, both financial planners agree a 401(k) is not the right source of money.

So going back to the question in the headline: Is getting a 401(k) loan a good idea? Given the drawbacks listed above, it’s probably not ever a good idea, but in some unique situations, it may be the best of your not-so-great options.

Of course, rather than waiting to find yourself in an emergency with limited options, a better course of action would be to get out of debt and bulk up your savings account now. If you’re not sure how, subscribe to the Money Talks News newsletter to get the best personal finance tips and advice delivered straight to your inbox each day.

For more tips on saving for retirement, watch the video below:

Watch the video of ‘Is Getting a 401(k) Loan a Good Idea?’ on MoneyTalksNews.com.

This article was originally published on MoneyTalksNews.com as ‘Is Getting a 401(k) Loan a Good Idea?’.

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How To Dodge Mortgage Insurance Fees When Applying For A Home Loan [Infographic]

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How To Dodge Mortgage Insurance Fees When Applying For A Home Loan [Infographic]

Today 2:30 PM Discuss Bookmark

Lenders Mortgage Insurance (LMI) is a one-off fee payable when borrowing more than 80 per cent of a property’s value. It’s yet another expense that can make life difficult for cash-strapped home buyers; even for a modestly priced property. This “hustler’s guide” from Home Loan Experts outlines the various ways you can reduce — or completely avoid — your LMI fee.

Australian house picture from Shutterstock

LMI can be a pain in the butt. It’s designed to protect the bank’s interests and can result in serious money woes if you default on your mortgage. As Home Loan Experts explains on its blog, if you borrowed $510,000 for a property worth $550,000, you could be paying over $23,000 upfront just to get your loan settled: not exactly small change.

The below infographic explains how to reduce or even avoid mortgage insurance altogether. Some of the advice will be unfeasible to most readers (you’re probably not going to become a doctor just to avoid an LMI fee) but there are also some viable tips that could save you a bunch of money. See for yourself!

[Home Loan Experts]


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Loan sharks could take advantage of payday lending caps, according to CAB


Loan sharks could take advantage of payday lending caps, according to CAB

DEBT ADVICE: Darlington Citizens Advice Bureau’s Dawn Gill and Neeraj Sharma

First published in News by Joanna Morris

LOAN sharks could cash in following caps on payday lending, according to the Citizens’ Advice Bureau.

Caps limiting the interest rate and fees instated by so-called payday lenders have been introduced by the Financial Conduct Authority in a bid to protect people struggling with debt.

As of Friday, January 2, companies such as Wonga – who previously had annual interest rates higher than 5,000 per cent – must comply with regulations that will see interest and fees capped at 0.8 per cent per day.

Under the new rules, the total cost of a loan will be limited to 100 per cent of the original sum and default fees will be capped at £15.

While the move has been welcomed by the Darlington Citizens Advice Bureau (CAB), the organisation has warned the changes may cause more vulnerable people to fall prey to loan sharks.

Darlington CAB’s Dawn Gill expressed fears that loan sharks could take advantage of those now unable to access as much money as they need.

She said: “Caps are a good thing but clients will still want money from somewhere – they’re being protected from high interest rates but companies may not lend as much.

“They may not be able to get as much as they were expecting or anything at all.

“If they don’t get what they want, they are in danger of reaching out to someone like a loan shark instead of coming to us, for example.

“We haven’t seen it happen yet but the changes are still new and it’s a worry.”

Ms Gill urged payday lenders to work with CABs in order to help their clients manage their finances.

She said: “The ideal situation would be for payday lenders to refer their clients to us before they take out a loan at all and let us help them to maximise and manage their income.

“I’d advise people to come to us and let us help them find ways to manage.

“We can help with benefits, cutting energy bills or working out incomings and outgoings and priorities.

“There are a lot of people prioritising paying back intimidating people who knocked at their door with money rather than paying their rent or council tax but they could end up losing their home.”

To anonymously report a loan shark, contact the Illegal Money Lending Team by emailing reportaloanshark@stoploansharks.gov.uk or calling 0300-555-2222.

[…]

Best Business Cash Indicator

You need cash to run your business. Then why don’t you know how to read your cash flow statement? It might be the truest way to tell when the tank begins to run seriously dry.

I don’t mean your profit and loss (P&L) statement and I don’t mean your balance sheet. I bet that lots of you run businesses that don’t even prepare a cash flow statement.

This statement combines your P&L and balance sheet to tell you what happened to your cash over a given period. It tells you if you create cash or use cash. And if you don’t create cash, you and your company might come in for an unhappy surprise.

Thought your P&L told you if you made money? Your P&L can tell you revenues, costs and expenses and whether you made money according to generally accepted accounting principles – guidelines that sometimes don’t help a lot with the realities of running a small business.

For instance, remember that bank loan you made a payment on? The principle of that loan doesn’t show up on your P&L; it does show up on your cash flow statement. Ditto the cost of that new truck you just bought for the business and the money you spent on increasing your inventory.

In your business, you either create cash or use it. If your business grows really quickly you might actually show a profit while having negative cash. Think of firms worth a lot on paper because they have big deals in the works – deals still yet to pay a dime.

Your cash flow statement tells it like is. These documents are one of the quarterly financial reports any publicly traded company must disclose to the U.S. Securities and Exchange Commission and – maybe an even harsher judge – the shareholding public. In your hands, this document is your best business friend who always puts the truth to you straight.

If you look at your cash flow statement at least monthly, you can see trends. You see if your inventory grows. You see if your principle payments to lenders are too high and you might see need to re-negotiate a better repayment schedule.

Once you understand your cash flow statement, you really start to get a handle on what’s going on in your business. And so do others.

Banks, for example, are very aware that cash reigns in your business. Your bank will take your numbers and look first for how many times your cash flow can make interest payments on your outstanding loans. If your cash flow is $200,000 and your interest payments $20,000, your bank will be happy.

Next your bank sees how your cash flow does paying both interest and principle. With the above numbers, if your annual bank payments total $50,000, your bank is still happy. If your annual payments total $150,000, on the other hand, your bank might not be as happy.

In short, to know how your bank thinks, know how to read and understand your cash flow statement.

Happiness (in business, anyway) is positive cash flow. Know how to spot it.

Follow AdviceIQ on Twitter at @adviceiq.

Josh Patrick is a founding principal of Stage 2 Planning Partners in South Burlington, Vt. He contributes to the NY Times You’re the Boss blog and works with owners of privately held businesses helping them create business and personal value. You can learn more about his Objective Review process at his website.

AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.

[…]

Dear John: Cash in pension after losing job?

Dear John: I am 58 years old and currently unemployed. I have been in the banking industry for the past 34 years. I lost my job in June.

While I have savings to last me through next July, I have debt that I would like to pay off. I am considering cashing in one of my pension plans with my previous employer. I know cashing in a pension is probably never a good idea unless you roll over, but I would like your advice on my situation.

I have a conventional pension plan worth $185,000 I am looking to cash in. I also have 401(k) plans that I will not touch totaling about $225,000.

Cashing in the $185,000 will allow me to pay off my mortgage, credit-card debt and private loans totaling about $60,000.

I am also saddled with student loans for my two daughters of about $40,000. Interest on the credit cards run about 9 percent and the mortgage is at 5 percent but only has 2 ½ years left to pay off. The private loan is no-interest, but the student debt is costing me 8 percent.

Payments for this debt total about $2,600 per month. These payments are eating up my savings, but I will still last until July.

Employment prospects do not look good. If I can pay off, I would be free of those payments and might possibly find a lower-paying job and not have to worry about the debt.

My salary in my banking career was in the mid-six figures — good money.

Even after cashing in, I would still have my 401(k) and my Social Security to live on when I reach 62. My wife will have hers at 62 as well.

She only has a small pension due her, which will pay about $150 per month. All of these incomes add up to about $4,700 per month once I formally retire. With no debt, I think am OK.

If I did not cash in the $185,000, that would give me another $1,500 per month. I do not believe I will have to pay any penalty to cash in as I was over 55 when I became unemployed.

I do not want to cash everything in and just live on Social Security alone, or work for the rest of my life. I’d like to find a job I can live with, even at a greatly reduced salary, and not have to worry about bills.

Please let me know your thoughts on my issue. Thanks for your time. Mike

Dear Mike: Ah, the Golden Years! Aren’t they great?

I asked Scott Brewster, a certified financial planner in Brooklyn, to opine on your situation.

“Sorry to hear,” says Brewster, who is a member of the Financial Planning Association. “It must be very stressful after 34 years in the banking industry to lose one’s job making mid-six figures and struggle to find another job.”

Brewster doesn’t think that cashing in your pension early is the solution you need.

“You probably are correct that since you were separated from service after age 55 you might not be hit with the 10 percent penalty on withdrawing your pension money,” he says. If the funds were in an Individual Retirement Account, the early withdrawal penalty would apply until the age of 59 ¹/? .

But Brewster warns that “you will get taxed on the withdrawal, and $185,000 cashed in might only leave you with $110,000 after taxes. Not only that, you would be reducing your retirement nest egg by close to 50 percent.”

He says the real issue is that you are struggling to find work and even with your loans paid off, you are going from making a mid-six-figure income to just looking to get by in a few years on Social Security and a 401(k) that is about equal to what you made in one year while working.

“My action plan for you,” says Brewster, “would be to make getting another job your No. 1 priority. Working on finding your next job eight hours a day is not enough. You need to put in overtime securing your next job so that you not only avoid cashing in your pension but are in a position to keep saving more for retirement and pay off your debts from your income.”

Mike, (this is John speaking) you and I know that the job market stinks and that you are at an age and salary level when employers think they can get a better deal with someone younger.

So you need to make prospective employers know that you don’t have what they call “salary demands.” You have, instead, salary suggestions. And that you are very flexible.

And you need to connect anyone from your previous job who might be able to help you find work. Beg them if that’s what it takes.

“If you work long and hard all the way until next July when your savings will run out, and you do not find a new job, then you can — without guilt — pull money from your pension, because then you have tried everything you possibly could to not do so,” says Brewster.

And even then, Brewster says, he would only pull out what you need to make the minimum loan payments and keep working at the job hunt. “And yes, it is a hunt. You have killed it for a long time, and you need to go back out and continue to kill it,” he says.

“With 34 years of experience under your belt, don’t sell yourself short. This period of unemployment will pass, and if you throw all your energy into getting to the other side, you will be stronger for it and will have your pension still intact along with your 401(k),” Brewster says.

Both he and I wish you the best of luck. Stay optimistic and smile when you interview. Prospective employers like to hire happy people.

Share this:

[…]

Public warned not to use moneylenders for Christmas cash

The Central Bank of Ireland today asked consumers to “think twice” before using the services of moneylending firms this Christmas.

Research on the Moneylending Industry last year showed that more than one in five consumers (21%) took out a new loan before another loan was paid off.

Of these, 27% of the consumers interviewed claimed that they had used their new loan to reduce an existing loan.

Director of Consumer Protection, Bernard Sheridan, said “Households often have additional expenses at this time of year, and consumers could be tempted to take out additional loans to cover these expenses, including from moneylending firms.

“This could take consumers into a rolling cycle of high-cost borrowing and potential debt, especially given the high-cost nature of moneylender loans, when compared with loans from banks and credit unions.

“If a consumer does choose to take out an additional loan from a moneylender they should check that the moneylender is licensed by the Central Bank.

“Moneylenders licensed by the Central Bank are prohibited from keeping any amount of a new loan to repay an existing loan.”

He also had advice for those experiencing financial difficulties.

“If you have missed repayments, you’re protected insofar as your moneylender cannot charge you extra,” he said.

“However, if you find yourself having difficulties managing your money, contact the Money Advice and Budgeting Service who offer free budgeting advice and will help you manage your debt.”

[…]

Payday loan adverts could be banned on television before 9pm …

Payday loan commercials could be banned from TV before the 9pm watershed, under proposals being considered by the UK advertising regulator.

The Broadcast Committee of Advertising Practice (Bcap), the body responsible for writing the rules for TV ads, is already looking at the content of payday loan commercials.

The government has now asked Bcap to extend the scope of its review to look at the scheduling of payday loans ads and a potential pre-watershed ban.

This extension of the investigation was revealed by Baroness Jolly, a Liberal Democrat peer, in a session in the Lords discussing the report stage of the consumer rights bill on Wednesday.

“Treasury ministers have asked Bcap to broaden the remit of its review to ensure that it also considers the appropriateness of its scheduling rules, as well as those around content,” she said. “Treasury ministers are writing to Bcap formally to set out this request. Bcap has agreed to this and will expand its review with a view to publication of its findings, in full, in the new year.”

The extension of the review will push back publication deadline of Bcap’s investigation into payday loan ads, which began in June and was due imminently.

The Advertising Standards Authority said it has banned 25 payday loan ads since April 2013.

The existing advertising code already prohibits payday loan ads from encouraging under 18s to either take out a loan or pester others to do so for them. The rules also require that ads must be socially responsible.

According to research by the media regulator Ofcom children on average see around 1.3 payday loan ads on television per week, out of around 17 hours of weekly TV viewing.

Payday loans ads comprised a relatively small 0.6% of TV ads seen by children aged four to fifteen, according to Ofcom.

The Consumer Finance Association, which represents payday lenders making up 60% of the multibillion pound a year UK industry, and Wonga have explicit policies not to advertise on children’s TV.

“We are pleased to see the government recognise that this is a problem,” said Joanna Elson, chief executive of the Money Advice Trust, the charity that runs the National Debtline.

“On the debt advice frontline we have become increasingly concerned that high cost credit is in danger of becoming normalised amongst young people. Restrictions on payday loan advertising before the watershed, on the same basis as those already in place for gambling and alcohol, would be a very welcome step.”

• To contact the MediaGuardian news desk email media@theguardian.com or phone 020 3353 3857. For all other inquiries please call the main Guardian switchboard on 020 3353 2000. If you are writing a comment for publication, please mark clearly “for publication”.

• To get the latest media news to your desktop or mobile, follow MediaGuardian on Twitter and Facebook.

[…]

0 Percent Car Financing Could Save You Thousands

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It’s car-buying season and if you read this column often, you know that when it comes to vehicles, I’m a fan of buying used and paying cash. But I’m also a realist. I know many of you are fans of buying new and taking out a loan. Here’s how you can save even if you disagree with my approach: 0 percent financing.

Shoppers Have a New Way to Save Money at WalmartHow to Get Half a Million More From Uncle Sam for Your Retirement

As a consumer reporter, I was skeptical of free auto financing, at first. After all in other businesses “0 Percent Interest!” is a come-on with potentially dangerous consequences. Take the furniture industry. Typically, if you sign up for zero percent interest on furniture, you have a year to pay off the loan in full. If you don’t, then not only are you charged interest, the interest is retroactive to the date of your purchase. Ugh. I’m happy to say that is not the case in the auto industry.

Zero percent loans are a good deal for car dealers, because cars are such a huge purchase that it’s a way to get people to buy. And they’re a good deal for customers because they can save you money, according to auto website Edmunds.com.

“I think people don’t realize how much you save by getting a lower interest rate,” said Edmunds Senior Consumer Advice Editor Philip Reed. “If people took the time to calculate it they would be stunned by how much they’re paying in interest and that’s money that’s lost forever.”

Actually, you don’t have to calculate it yourself. A new analysis by Edmunds says a zero percent loan can save you as much as $3,554 compared with a typical auto financing deal! To give you an idea, the website did the math using a $28,000 loan at 4.31 percent for 67 months.

Understanding the potential savings means you should actually factor zero percent financing into your car shopping. If you’re trying to choose between two different makes and models, perhaps you can break the tie by going with the one that has a free financing deal. Edmunds lists these deals on the Incentives and Rebates page of its site.

A few things to know:

•Free financing is only offered to people with tip-top credit.

•Most zero loans are shorter, like three years long.

•Incentives such as zero percent financing are often regional. Be sure to plug your zip code into Edmunds to find the offers for your area.

•Zero percent financing is most common for vans, followed by non-luxury cars and non-luxury SUVs.

And one final warning from your humble columnist who’d rather see you buy used and pay cash: don’t let a zero percent financing deal lure you into buying a more expensive car than you can really afford. And keep that car as long as you can stand it to save the most money of all.

Opinions expressed in this column are solely those of the author.

Elisabeth Leamy is a 20-year consumer advocate for programs such as “Good Morning America” and “The Dr. Oz Show.” She is the author of Save BIG and The Savvy Consumer. Elisabeth is also a professional speaker, delivering talks nationwide on saving money, media relations, and career success. Elisabeth receives her best story tips from readers, so please connect with her via Facebook, Twitter or her website, to share your ideas.

[…]

New cash advice centre to beat the loan sharks

A NEW scheme has been launched in north Glasgow to keep residents out of the hands of loan sharks.

Last year, the Big Lottery awarded Glasgow organisation Scotcash a £1million grant to expand its services over the next four years.

It provides affordable credit, financial support and guidance to people who may otherwise not get a loan.

Scotcash has the support of a wide range of organisations including the city council, the Scottish Government and Glasgow Housing Association.

Unlike credit unions, people do not first have to save cash before they can take out a loan with the organisation.

Scotcash opened its first office on the High Street in 2007 and has gone from strength to strength.

This month it extended its services to the north of the city and plans to operate in the south from October next year and in the west by 2016.

Linzi Wilson, Scotcash finance and marketing officer, said: “Alongside credit unions, we work with some of the most vulnerable people in the city who use high cost and pay day lenders or even loan sharks.

“We offer affordable credit and where a loan is not the best option, access to free high quality money advice is offered on site through our partners in the Citizens Advice Bureau.

“In addition to this, we can open basic bank accounts and provide financial education helping improve people’s long term financial outlook and start them on the route to becoming financially included.”

Scotcash will operate five days a week from housing association offices in the north of the city.

Chief executive Sharon MacPherson said: “Scotcash is committed to supporting individuals and communities most in need and we are delighted that with Big Lottery support we are bringing our services closer to local communities in north Glasgow.”

[…]

Young people with debt more likely to get payday loan than go to bank

Young people under the age of 25 are more likely to turn to payday loan companies such as Wonga to make ends meet than approach their bank, building societies or a credit card provider, according to Citizen’s Advice.

It analysed 30,000 of the most serious debt problems it sees in its bureaux and found that while 10% of these were suffered by 17-24 year olds, payday loans accounted for 62% of the credit used by this age group. Only 8% of the 3,000 youngsters were in debt because of mainstream credit such as overdrafts, bank loans or credit cards.

Over a third of those who were suffering severe debt problems were not “Neets” – Not in Education, Employment, or Training – said Citizen’s Advice, but were in work.

“Generation Y is fast becoming generation credit,” said Citizen’s Advice chief executive, Gillian Guy. ““It is a big concern that so many young adults are turning to some of the most expensive types of loan to get by. Taking out a payday loan in your late teens or early twenties can have significant and damaging consequences for later life.”

Less well-known types of high-interest credit, such as guarantor and logbook loans, are also contributing to the severe debt problem suffered by the youngest borrowers. Guarantor loans are those in which another individual is listed as being liable for repayments if the borrower cannot make payments, while logbook loans use people’s car as security.

Separate research from the Financial Conduct Authority found that around 40,000 consumers took out logbook loans in 2013, typically borrowing £1,000 a time, although lenders offer sums of up to £50,000. Citizen’s Advice said it expected the number of logbook loans taken out to rise by 61% this year.

[…]