I am trying to decide if I should take a loan from my own 401k. Here is my situation. I have a bit of credit card debt, at 13%. I am paying it off at a rate that will take 30 months to get rid of it completely. One option I have is to take a loan out of my own 401k. The loan would be for about half the debt, allowing me to pay down the remaining portion in about 15 months.
The interest rate on the 401k loan is 7.43% APR. I understand that if I leave my company, I will have to pay this back immediately. Also, from what I have read, it seems as if the interest payments go back into my 401k account?
I am 24 years old, and not in any real danger of losing my job anytime soon (pretty much have it locked for the next 21 months gaurenteed).
I am looking at a 24 month term to the loan.
The main drawbacks as I understand them are as follows:
1 – miss out on market growth – I view paying off the credit card debt as guaranteed 13% return
2 – double taxed on the interest – works out to about $150 for me, not a huge deal. Big savings over the $150 I pay in interest charges each month.
Anyone know personal finance well enough to give me some good solid advice on this?
I am not a financial professional by any means. Everything I’ve read says never ever do it, except in truly dire circumstances. 13K debt is nothing to sneeze at, but it doesn’t seem worth it.
http://invest-faq.com/articles/ret-plan-401k.html has a good discussion. “The cons are that your money is not growing for you while it is out of your account, there may be fees involved, the loan must be paid back immediately if you change jobs, and a loan default is treated as an early withdrawal (with taxes and penalties due). Given the total lack of job security that most workers have in 2005, there are considerable risks to this type of loan.” There is also a 10% fee for loans.
http://www.mostchoice.com/financial_planning_401kira_loans.html also seems pretty good. Both these sources also say that if you should lose job for any reason, you’re in trouble. " If employment is terminated for any reason, the remaining balance of the loan may come due in full immediately upon departure. If the planholder is unable to come up with the balance of the loan by the required deadline, the loan automatically defaults. To make matters worse, the remainder of the account then becomes taxable as if it were an early distribution, plus the remaining amount will be subject to the 10% early withdrawal fee."
My ex had 40K of credit card debt, and he took out a 401K loan to pay it off. For him, it was the best thing to do, and the only way to pay off the debt without paying the credit card interest amount, which was really high. He completely avoided any more credit card interest, and the 401K “interest” was paid back to himself. Yes, he lost something in his 401K account, but it was a one-shot deal that hopefully taught him a lesson to never again go into credit card debt! The alternative was probably to declare bankruptcy, although we didn’t seriously intestigate that.
Are you sure you aren’t going to run the CC debt back up?
You say you are paying off half of the cc debt. Will you be able to make the same payment level to the cards even though they are taking out the loan payment? You will have less income for the duration of the loan.
Well, two things come to mind. First, it seems like the solution to debt should not be borrowing more money… but I understand this, and have my spending in control. If I am going to have to pay interest, why not pay it to myself rather than the cc companies?
As for the same payment, from my understanding, my 401k contributions will cover the payments, so I should be able to continue to make my monthly payment to the credit cards while I pay the 401k debt.
This is a common misconception regarding 401(k) loans. Just because the repayments are made with after tax dollars does not mean that there is double taxation on the interest you repay. See here for a good discussion of the subject.
You are definitely going to miss out on the market value change on the money you take out of the 401(k) during the term of the loan. Depending on what you’re invested in, and how the market plays out, that may be good or bad. If you’re comfortable with that risk, and you are VERY sure you’ll be employed at this company during the entire two year term of the loan, I say go ahead.
After the loan is over, maybe you could increase your salary deferral election by the amount of the loan payment to increase your savings. Also, no matter what you do, make sure you are taking full advantage of any matching contributions the plan offers.
Apparently my advice on matters of alcohol is also of value to some. This wasn’t really financial advice though. I was just giving you some things to consider in your decision making process.
IANAFinance Advisor either, but I would leave the 401k alone, let the free money work for you.
NOTE: I would only recommend this if you have your spending under control and if you keep it that way. As this solution could really mess with you if you fall off the spending wagon.
I really really really hate recommending getting another credit card, but what about a 12 month 0% with a balance transfer? You said it would take you 30 months to pay off your current debts with a rediculous 13%, but with a 0% card for 12 months, just use whatever interest you would be paying towards the other card(s), and put it towards the principal on the new card, plus scrape what ever you can and put it towards the principal also. Pay your other obligations first (Mortgage (or rent), car payment (gas), utilities, family needs…) And cut things like “wants” out of your life immediately. It’s worth saying twice:
Cut things like “wants” out of your life immediately!
Eat two meals a day, and pay that sucker off with whatever you have left. I know it’s a lot to ask of yourself if you’re not already doing it, but you’d be surprised how much you save when you’re not ordering pizza 3 times a week, buying DVD’s and CD’s and such every month, those savings add up quick! Put everything remaining towards the new card EVERY MONTH, and DO NOT SKIMP! At the end of the year, if it’s not already paid off, do it again. There will be a spike in interest at the end of the 12 month term, as well as an increase in interest if you miss one single payment, so watch out for that too.
Also consider the advice of everyone else here as well. There are 8 different ways you can do this, but you have to find out what is going to work for you. If you feel that you might be splurging on credit again, don’t even take my advice. It can put you in a position from bad to worse quickly.
Note: Your loan repayment is withheld from your pay, and is a completely different transaction from your voluntary contributions. If you continue to contribute at the same level, your take home pay will be lowered by the amount of the loan repayment until the loan is paid off.
Your contributions do not have anything to do with the loan repayment.
One of my secretaries has used the 401k loan program to finance a child’s dental work and again to remodel her house. She likes the program. I’ve never used it, being able to get a home equity line of credit with little trouble or expense.
Whatever you do, if you are taking this loan out to reduce credit card debt, please be damn certain that you DO, in fact, decrease credit card debt. If it was any of my business, I’d advise you to borrow enough to pay off all of the credit card debt, and then draw the line at making any more.
There’s no way on earth I’d do that. Why not just make extra payments on the card?
My thing is that no matter how much I have to hunker down I will not touch my retirement money until I retire. You’re not making 7% since you’re the one paying it so it puts your retirement earnings at negative 7% plus takes away from the base money working for you. That’s just my opinion.
I question that as well…Have you looked into alternatives? ParentalAdvisory makes a good point - there are CC offers out there to transfer your balance to for low-or-no interest rate for the first year.
Also, have you gone to your bank (or Credit Union)? If you have a steady job and an OK credit rating, you might be able to get a personal loan for less than the 13% you are paying now. Be honest - tell them what you want to do, they might have other options for you.
Lastly - have any relatives looking for a return higher than current tbills or CD’s? My mom loaned me money at Fed Funds + 1% because she couldn’t get any better deal on low-risk investments. She knew I wouldn’t default on her, and she made more money than she would have in the end. Happiness for us both.
I think 401k loans are great. I consider them a hedge against a market downturn. Should your investments go south for a year (which can definitely happen), the money you pulled out is not going to shrink. So it’s a bit of diversification for your portfolio, rather than an unknown return on your investment from the market you get a guaranteed return from yourself.
Here’s my rule of thumb. ANY claim of “double taxation” is bogus. I have not seen one legitimate example yet.
Instead of borrowing money from your 401k, why not just stop contributions to it for a year and use that money to pay off your debt quicker? Your money that is already in there will continue to grow. I know some people will say 'but then you lose your employer match" but is it more than the hit you will take for borrowing plus the interest you will pay on the credit cards? Plus I think the psychological effect of having no debt is worth it. It appears that you are going to borrow money from the 401k but continue to make auto payments into it during the time you are repaying the credit card debt, to me that does not make sense. I would stop contributions and put every penny into the debt without borrowing anything, and try to pay it off in a year, then you can start contributing again and even contribute more since you have no debt payments.
I would not borrow from a 401k unless it is a true emergency. I would have to be having a medical emergency or be about to lose my house or something really really dire before I would touch that money. There are other ways to pay off credit card debt.
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