Adults over the age of 55 are undertaking home remodeling projects in record numbers. Spending on these projects by these older individuals grew 150 percent over the last 10 years. Often, these renovations make it easier for retirement-aged homeowners to age in place. For example, remodeling might include adding a master bedroom on the ground floor, remodeling a bathroom to allow for a walk-in shower or adding non-slip flooring during kitchen remodeling.
Financing these projects often has a tempting solution: Tapping into the 401K. However, while doing so has its advantages, taking this step also requires serious consideration. Here is a look at some of the pros and cons of using your 401K for home remodeling, and some key considerations that can help guide your decision.
Pros of Using A 401K for Home Renovation Financing
There are some good reasons that many homeowners opt to withdraw from their retirement savings in order to finance their home projects. Here are three of the most common, and advantageous, reasons to consider taking this step.
Taking money out of your retirement savings is far less complicated than taking out a new loan. For example, you probably do not need to meet any qualifying requirements in order to withdraw the money – An appealing option if you struggle with your credit.
In addition, you may receive the money from your loan as a direct deposit in your checking account in as little as a day, or, at most, in a few weeks. Shortening the time it takes to get your loan, complete your renovation project and begin enjoying your home improvements makes these loans a tempting source of financing for remodeling projects of all kinds.
In addition to being faster to access, the funds from a 401K may also be available for less than taking out a traditional loan. Often, the interest rates are lower than traditional interest rates, due to the fact that you are essentially borrowing from yourself. Paying less for your loan over time can make withdrawing the money an appealing option, particularly if you are trying to renovate your home on a tight budget.
Flexible Loan Terms
Faster access to cash and lower interest rates combine with flexible loan terms to make retirement withdrawal an attractive choice for many 55+ homeowners. In particular, many individuals can repay their loan faster than the loan terms specify without suffering a prepayment penalty.
Cons of Using A 401K for Home Renovation Financing
Despite its advantages, a 401K loan also has some drawbacks you should take into consideration before borrowing. Here are three of the biggest disadvantages of taking this step.
Loss of Retirement Savings
Perhaps the most serious drawback of the 401K loan, particularly for individuals nearing retirement age, is the loss of savings that a withdrawal represents.
Not only do you lose the cash that you take out for your home renovation, but you also lose out on the growth that money would have experienced if it had remained in your account and accrued interest. That can make retirement less financially secure.
If you are not yet 59.5 years of age, withdrawal from your 401K comes with an early withdrawal penalty of about 10 percent. This penalty can significantly cut into the funds you have available to use toward your remodeling project.
For example, if you borrow $35,000, you would owe a penalty of $3,500. That would reduce the cash available to spend to $31,500. If you cannot afford this fee, you may want to pursue an alternative financing option.
Usually, you have 5 years to repay your 401K loan. If you do not repay the loan in time, you may owe additional fees. For example, the IRS may consider your loan to be a disbursement, and charge you taxes on your withdrawal. In addition, certain life changes, such as losing a job, may make your loan immediately payable. If you cannot repay the loan amount, you may be subject to fees that put further financial stress on your life and your retirement.
If a 401K is a central part of your retirement planning, you should carefully think through the implications of removing money from that account to pay for a home renovation. Here are some considerations to think through before making your decision.
Alternative Financing Options
Before taking out a 401K loan, you may want to consider alternative ways to finance your home remodel. Here are a few ideas that may cost you less in the long run and keep your retirement savings secure:
- Draw out of your regular savings
- Take out a home equity line of credit
- Refinance your home
- Take out a personal loan
- Get a home equity loan
Your Required Cash Amount
Another factor to consider before making a retirement withdrawal is how much money you need for your project. There may be limits on how much you can withdraw from your 401K. Will it be enough to fund your remodeling costs? Alternatively, you may not want to withdraw money for a small project that may only cost a few hundred or a few thousand dollars. Save your withdrawals for large amounts of money that are critically required.
Fees and Taxes
Before you commit to an early withdrawal from your retirement account, consider exactly how much it will cost you. Can you afford it within your retirement planning? Will the taxes and fees leave you with enough money for your project? How much money will you lose from your account over the long term? Are alternative financing options less expensive over time? Know exactly what you are paying, now and over time, to access your 401K funds.
If you want to enjoy a home renovation project that meets your needs, you need a guide who understands every step of the process. At Reliable Home Improvement, we help you get added ROI from your home with projects that we oversee from designing to building to completion. Let us provide you with the solution you need, right here in the Chicagoland area.