Should I take a 401k loan to pay off my credit card debts?

Question

I have credit card debts equal to 15% of the value of my 401k. I can take a loan from my 401k and pay it back over 5 years at 8.5%. Currently my credit cards have a rate 3-5 percentage points above that. I am 30 years old and contribute the max to my 401k. My feeling is that I might as well be paying the interest to myself instead of to the credit cards. Also I am 25-30 years away from retiring. I can use the money I save from paying my credit cards each month and start a Roth IRA and/or invest it in mutual funds and stocks as well as college plans for my daughter. I also have money in mutual funds that I could liquidate to pay my credit cards. What do you think is the best option? I figure I am young enough where this is a good option because I know you really are not supposed to use your 401k for loans

Answer 1

You already answered your question.

Your retirement account is JUST FOR THAT.

The only exception that makes sense is to take out a 401(k) loan as a down payment on your first home which is another 30 year investment program or for a hardship such as a physical disability where you have no "emergency reserves" to even survive --> there is no need in being disabled AND homeless.

Taking out a loan on a 401(k) for a down payment on a home makes sense because both assets (the home and the 401(k) account are long-term assets).

Taking out a loan on your 401(k) to handle personal debt is a usually a recipe for disaster -- especially when you know full well that you might charge the cards back up should an emergency arise.

If you are that PRESSED to pay off the credit cards, just get a personal loan (not a home equity loan) to consolidate your debt.

You are doing the right thing WITH THE WRONG INSTRUMENT.

You don't pilfer your nest egg unless you are buying something that is a sure-bet to appreciate over DECADES.

Good luck.

Answer 2

This is what I would do. Do not touch your retirement accounts. Next take a calendar and with each bill divide the minimum payment into 2 payments. Every 2 weeks mark down on the calendar the 1/2 payment for each bill. This is what you will pay the credit card companies. This will cut the interest in half. Credit card interest are calculated on a 28-day cycle. By paying on a bi-weekly basis or bi-monthly you are reducing the cycle down to a 14-day calculation. Also, this will raise your credit scores dramatically. The money that you are saving each month doing it this way you can place into that Roth IRA or college fund. Another thought to ponder is credit cards have a 35% threshold. You never want to spend anymore than 35% of your credit limit.

Answer 3

First I am glad to hear consumers thinking like this.

This is an excellent idea given your situation. Paying 8.5% beats 11% every day of the week...and if the whole thing will be paid in 5 years it is better than amortizing the debt into the home over 30 years. This is a prudent method of debt consolidation that will work IF you put the cards in dry dock.

I write a blog on the subject of credit management, mortgages, real estate trends, etc. Check it out for more information that may be helpful.

Answer 4

Don't take the money out of your 401(k). The money you have in it now is the most expensive to use because you will lose the benefits of compounding. $1,000 in the account today that is taken out and replaced in one year at 8.5% will cost you a lot more than you thought in the long run.

$1000 invested today at 8.5% compounded monthly for 30 years will be worth $12,692.50.

That same $1000 invested one year from now at 8.5% compounded monthly for 29 years will be worth $11661.70.

You lose $1,030.80 ; which is the loss of compounding that $1000 of 401k money for 30 years versus 29 years. Almost any other option is better.

Answer 5

NO, NO, NO.....truly.....don't touch your 401K....just because you can, doesn't mean you should........really.....

Just temporarily stop your contribution and throw that monthly amount, plus anything extra toward your debt........its only temporary and you don't lose out anything......

"You are NOT just paying yourself the interest".....that is wrong.

Take your medicine - which is stop contributing to your 401K....suck it up ....and be permanently done with it.....

I would liquidate non retirement accounts (mutual funds) to pay off crappy consumer debt, but don't touch your 401K.....don't ....don't ....don't....

Answer 6

settle out the debts and pay back half if you can qualify at www.fdnsolutions.com