Abstract
"This paper uses a hypothetical debt scenario to compare the costs of four types of loans to fund consumption. Results show that, under reasonable assumptions, 401(k) loans are cheaper than credit card and high-cost loans. In certain cases, 401(k) loans can be even more inexpensive than home equity lines of credit. By switching from high-cost loans to 401(k) loans, households can save up to 130 percent of the loan cost. The cost saving from a 401(k) loan is higher when 401(k) investment returns and 401(k) loan interest rates are low and when marginal tax rates are high. Findings from the National Financial Capability Study surveys indicate that despite the cost advantages, most people use 401(k) loans as a last resort. This can lead to hundreds of thousands of dollars in retirement wealth loss per household. Financial advice does influence borrowers to make better use of 401(k) loans. However, planners may still need to take a more proactive role in introducing 401(k) loans to help clients make better loan choices."