Well, the President signed those new credit-card regulations into law today. Now we wait and see if card companies start pulling back on credit lines and perks like we’ve been told they might. If that does happen, one option you might consider is borrowing against your 401(k). What 401(k)? you might be asking. Fair enough. But if there is any there there, think about it. According to a paper put out today by Fed economists Geng Li and Paul Smith, we don’t borrow from ourselves nearly enough. I quote:
[M]any 401(k)-loan-eligible households carry relatively expensive consumer debt that could be more economically financed via 401(k) borrowing. In the aggregate, we estimate that such households could have saved as much as $5 billion in 2007 by shifting expensive consumer debt to 401(k) loans. This would translate into annual savings of about $275 per household—roughly 20 percent of their overall interest costs—with larger reductions for households that carry consumer debt at high interest rates or who hold larger 401(k) balances.
We propose that this apparent puzzle—why households would not take the opportunity to reduce their interest costs by 20 percent or more—is an indication of either a willingness to pay to avoid the risks of 401(k) borrowing, or a common financial mistake. We posit several reasons why households might choose to borrow less than expected from 401(k) plans. They may be rationally averse to the risk of losing their jobs and having to pay back the loan in a short time frame. They may be expecting higher 401(k) returns than the after-tax interest they’re paying on outside loans (or, at least, averse to the risk of such a scenario). They may rationally acknowledge self-control problems in spending by walling off 401(k)s in a separate mental account that is unavailable for current consumption. Alternatively, they may simply be making a mistake—for example, they may be confused about the potential advantages of 401(k) borrowing, or they may carry a credit card balance despite their intention to pay it off in full every month.
That last part sounds similar to something I’ve read before.
Barbara!
