Investing for retirement is a long-term process. People who begin to invest early can take advantage of the effects of compounding and see exponential growth in their accounts. However, money can only grow at an exponential rate when it goes untouched. In the current economic climate, many people may consider borrowing from their retirement accounts in order to make ends meet. However, taking a small amount out now could potentially mean that much more will be lost down the line since less growth will be possible.
Recently, Congress passed the CARES Act, which enables penalty-free withdrawals from retirement accounts, as well as retirement account loans. While it’s better to use these accounts rather than to fail to meet your monthly financial obligations, it can limit growth because you are no longer compounding interest. For this reason, individuals who are in a financial bind may want to consider options other than borrowing against a 401(k) or similar retirement account. These options include:
People who own a home can sometimes refinance their mortgage and take cash out at closing as a sort of loan. This option could prove especially helpful in the current economic environment due to historically low interest rates. Ultimately, individuals may end up saving money in the long run by refinancing, although it is important to factor in the various fees incurred as part of this process when making this calculation. Importantly, this strategy typically requires that you work longer to pay off your mortgage unless it is refinanced into a shorter term. Also, individuals should appreciate that the tax situation around mortgages has changed. Through 2025, people can only deduct mortgage interest from taxes on loans up to $750,000 if their home is their primary residence and deductions are itemized. If people refinance an existing loan greater than $750,000, the threshold is $1 million. Another point to consider is that a cash-out refinance can sometimes allow people to get rid of mortgage insurance and thereby save money.
Home Equity Loan
Another option for homeowners is a home equity loan, which involves borrowing against the value of your property. Equity in a home increases as people pay down their mortgage balance and as a result of appreciation in the market value. Most lenders require that people have at least 20 percent equity and maintain that amount after taking out a home equity loan. Take, for example, a home worth $300,000. The amount of equity needed is 20 percent of that value ($60,000) plus the value of the loan. Thus, to take out a $20,000 loan, individuals need to have $80,000 in equity. Homeowners can no longer deduct interest paid on home equity loans from their taxes unless the money is used specifically for renovations on that property. Also, this option can involve hefty closing costs, so it makes sense to shop around and see who offers the best deal. Individuals may also want to consider the other options on this list if they can only borrow a small amount considering the associated fees.
Zero-Interest Credit Card
In general, individuals should avoid taking on credit card debt whenever possible, but one important exception is the zero-interest offer. People who have great or even good credit can often qualify for a special introductory rate or a zero-percent APR balance transfer. While both of these offers can help people to get cash quickly, it is important to look at the fine print. Individuals should only opt for these deals if they feel confident that they can repay the balance before the special rate period ends. Cards can vary in terms of how long the special rate will last, although a range of between 9 and 18 months is most common. This option is the riskiest because it may put people in a situation of incurring additional high-interest debt. The fine print will lay out the specific terms of the deal. Sometimes people will be forced to pay all interest if the balance is not covered before the introductory period ends. Also, a late monthly payment can sometimes cancel out a deal.
People who do not own a home or who do not have good enough credit to qualify for a zero-interest credit card deal may need to consider a personal loan. Also, individuals who do not wish to borrow against their home or who do not have enough equity for a loan may want to consider this route. These types of loans typically have higher interest rates than home loans since they are not secured, meaning that they are not tied to a piece of property that acts as collateral. Thus, the lender takes on higher risk, which means a larger interest rate. Also, the interest on personal loans has never been tax deductible. The interest rate on personal loans can vary quite a bit, from as low as 5 percent to as high as 36 percent, as of March 2020. The rate, which often depends on creditworthiness, can change between lenders. One draw of a personal loan is that it does not come with the same steep closing costs as a mortgage. However, it is important to take out a loan that you can feasibly repay.