The Top Three Personal Financial Pitfalls to Avoid
There are three financial strategies that seem to make good financial sense at first glance, but have the potential for abuse.
Here are the potentially appealing strategies and their dangers:
1. Purchasing the Largest Home You Can Afford.
Many individuals calculate the maximum amount they can borrow and then purchase a home based on that amount. Then, they find their budgets strained, with little money left over for other expenses. It’s a better personal finance strategy to do an in-depth review of all your expenses, deciding how much you’re comfortable devoting to a mortgage payment. You want to make sure there will be money left over for other financial goals and that unforeseen problems won’t prevent you from making your mortgage payment.
2. Paying off Your Credit Card Debt with a Home-Equity Loan.
Credit card and other consumer debt typically carry high interest rates that are not tax deductible. Home-equity loans, on the other hand, typically have lower interest rates and the interest is tax deductible as long as the balance is less than $100,000. Thus, using a home-equity loan to pay off consumer debt replaces higher interest, nondeductible debt with lower interest, tax-deductible debt. This is not necessarily a bad strategy, but the danger is you will run up credit card balances again. In that case, you reduced your home’s equity without improving your financial situation.
3. Get a Loan From Your 401(k) Plan.
Most 401(k) plans allow participants to borrow against their balances, believing it will increase employee participation by allowing access to funds before retirement age. The loan is not considered a distribution, so it is not subject to income taxes or the 10 percent early withdrawal penalty. Typically, interest rates are reasonable and the loan is fairly easy to obtain. Any interest paid on the loan is going back into your 401(k) plan.
The danger is that most people will have trouble saving enough for retirement without regularly dipping into their 401(k) plans. Also, some of your investments are sold to provide the loan proceeds. Even though your original contributions to the plan were made with pre-tax dollars, the money used to repay the loan is made with after-tax money.
Another danger exists if you leave your job before the loan is paid off, since you must then repay the entire balance in a short time or the balance will be considered a taxable distribution, subject to income taxes and possibly the 10 percent federal income tax penalty if you are under 59 1/2 years of age. For more information and assistance with related questions please contact us at 800-606-2292 or leave us your contact information here.
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