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New evidence on 401(k) borrowing and household balance sheets

  • Geng Li
  • Paul A. Smith
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Despite news reports suggesting a rise in 401(k) borrowing in recent years, we find that the share of eligible households with 401(k) loans in the 2007 Survey of Consumer Finances was about 15 percent, roughly what it has been since 1995. We find that the best predictors of 401(k) borrowing appear to be the presence of liquidity or borrowing constraints and the size of 401(k) balances relative to income. Since the ongoing financial crisis has likely caused these factors to move in opposite directions, the predicted effect of the crisis on 401(k) borrowing is ambiguous. More fundamentally, we find that many 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 posit that households might utilize 401(k) loans less than expected due to risk-aversion, self-control problems, and confusion about the potential gains, and suggest better financial education that clarifies the conditions under which 401(k) borrowing is advantageous. Finally, we note that allowing households to repay 401(k) loans gradually even after separation from their employers could improve household welfare by reducing the risks of 401(k) borrowing.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2009-19.

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Date of creation: 2009
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Handle: RePEc:fip:fedgfe:2009-19
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  4. Duflo, Esther & Gale, William & Liebman, Jeff & Orszag, Peter & Saez, Emmanuel, 2005. "Saving Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment with H&R Block," CEPR Discussion Papers 5332, C.E.P.R. Discussion Papers.
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  12. Marianne Bertrand & Dean S. Karlan & Sendhil Mullainathan & Eldar Shafir & Jonathan Zinman, 2005. "What's Psychology Worth? A Field Experiment in the Consumer Credit Market," Working Papers 918, Economic Growth Center, Yale University.
  13. Saez, Emmanuel, 2007. "Details Matter: The Impact of Presentation and Information on the Take-up of Financial Incentives for Retirement Saving," CEPR Discussion Papers 6386, C.E.P.R. Discussion Papers.
  14. Love, David A., 2007. "What can the life-cycle model tell us about 401(k) contributions and participation?," Journal of Pension Economics and Finance, Cambridge University Press, vol. 6(02), pages 147-185, July.
  15. Bertrand, Marianne & Karlan, Dean & Mullainathan, Sendhil & Shafir, Eldar & Zinman, Jonathan, 2009. "What's Advertising Content Worth? Evidence from a Consumer Credit Marketing Field Experiment," Working Papers 58, Yale University, Department of Economics.
  16. Esther Duflo & Emmanuel Saez, 2000. "Participation and Investment Decisions in a Retirement Plan: The Influence of Colleagues' Choices," NBER Working Papers 7735, National Bureau of Economic Research, Inc.
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  18. Annamaria Lusardi & Olivia S Mitchelli, 2007. "Financial Literacy and Retirement Preparedness: Evidence and Implications for Financial Education," Business Economics, Palgrave Macmillan, vol. 42(1), pages 35-44, January.
  19. Geng Li & Paul A. Smith, 2008. "Borrowing from yourself: 401(k) loans and household balance sheets," Finance and Economics Discussion Series 2008-42, Board of Governors of the Federal Reserve System (U.S.).
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