Borrowing

Why Suze Orman says borrowing from a 401(k) is 'one of the more foolish things you can ever do'

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Suze Orman
Marc Royce | Copyright Suze Orman Media Inc.
Key Points
  • Borrowing from a retirement account could mean giving up on gains in your portfolio while your cash is out of the market, Suze Orman points out.
  • Cosigning a loan is another potential money mistake, she says, as it can leave you on the hook if the primary borrower screws up.
  • And getting married without a frank money discussion? "You're the biggest financial fool of them all."

In an ideal world, every money decision you make would be numbers-driven and rational. After all, the classic rules surrounding investing, saving, spending, and borrowing money essentially revolve around math.

In reality, for almost everyone, financial decisions come with an emotional aspect. That's not always a bad thing. Understanding your tolerance for risk, for instance, can lead you to invest in a lower-volatility portfolio that doesn't have you up tossing and turning when markets get jumpy.

But if you let the emotional aspect of your decision-making process take over, you could find yourself in dangerous territory, even if you're just trying to help out a loved one says Suze Orman, host of the "Women & Money ... and Everyone Smart Enough to Listen" podcast and co-founder of emergency savings firm SecureSave.

Among the biggest goofs that people make, she says, is letting a short-term need for money jeopardize long-term financial plans, like by borrowing money from retirement accounts such as a 401(k). "You may think you're smart because you're using the money and paying yourself back with interest," she says. "But it's one of the more foolish things you can ever do."

Read on for three common mistakes Orman says people make when they let emotions get in the way of solid financial choices.

Mistake No. 1: Borrowing from retirement accounts

Never heard of a 401(k) loan? Here's how it works. You can borrow up to $50,000 or 50% of the vested balance of your account (whichever is less) on a tax-free basis. You'll owe "interest" on the payments, but the amount you pay goes toward your account balance.

Unless you're using the money to purchase a home, you'll typically have to pay the loan back within five years. If you lose or leave your job, however, you may be required to repay the balance quickly.

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Fail to follow the repayment schedule, and you'll be taxed on the outstanding balance of the loan and owe a 10% penalty to the IRS for early withdrawal. What's more, points out Orman, "you may have that money out of the market during a time that the market rallies," meaning you're missing out on valuable compounding gains while your money sits on the sidelines.

And if your financial situation doesn't improve, you may have crippled your long-term finances by taking that money, Orman adds.

"If you had to claim bankruptcy, remember that money in a 401(k) is, in most cases, protected from bankruptcy," she says. "So you take money out of desperation from your 401(k), you pay off whatever needs to be paid off, your situation doesn't change, and you still don't have any money. Now, if you have to claim bankruptcy, you've taken money out of your 401(k) that could have been protected. It's a seriously foolish thing to do."

Mistake No. 2: Cosigning a loan

Wanting to cosign a loan for someone you care about is understandable. Maybe you know someone who has fallen on hard times over the past few years and needs a helping hand. Or maybe you're looking to help out a young adult child with a thin credit history. Adding your signature could help this person get a loan that a financial institution would otherwise be unwilling to give them.

But once you put your emotions to the side, the calculus behind whether or not to cosign is simple, says Orman: "If the bank won't give that person a loan, nor should you."

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That's because cosigning makes you legally responsible for the debt if the primary borrower falters. If your loved one fails to make on-time payments, you could face repercussions, such as dings to your credit score or responsibility for the outstanding debt.

"What's interesting is how many people for the first time in years are writing me again saying they cosigned a $7,000 for their son's car," Orman says. "The son couldn't pay it, so they ended up paying it. Then the son crashed the car. Now they owe $7,000 even though they don't have a car. Now they need to buy a car, but they can't because they're screwed for their son's car."

Mistake No. 3: Ignoring money matters in your relationship

If you're thinking of getting married, you'll have to be willing to overlook or accept some of your partner's bad habits and flaws. But don't let your love for someone allow you to turn a blind eye to their finances, Orman says.

"If you marry somebody, and you don't know their FICO score, how much debt they have, what they have saved, whether they're a spender or a saver, you're the biggest financial fool of them all," she says. "Because you're the one that's going to end up losing."

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Money is a taboo topic for many, but it's essential to have a frank conversation with your partner before you make a commitment, Orman says. "You spend the majority of your life working, saving, and investing money, but you're more comfortable talking about sex than money? Get a life," she says.

"If you can't sit down with someone you want to spend the rest of your life with and say 'Let's sit down and check our FICO scores,' what's going on with you?" she continues. "If you can't do that, you're not mature enough to get married, because you're acting like a financial two-year-old."

So bite the bullet, she suggests, and have what might feel like an uncomfortable conversation. If you discover that your spouse-to-be has poor money habits, such as rampant debt or a serious spending problem, it's time to have a reckoning about how their money habits could affect your life together.

"This is a person who has not done anything on their own to try to help their situation, and now they're going to change their ways because of you?" Orman says. "I wouldn't marry that person for at least a year, until I had seen that they'd changed their ways on their own and you've seen serious improvement."

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