Is a 401(k) loan the solution to end your credit card debt?
Are you contemplating putting your savings for the silver years on the line to pay for daily groceries or you firmly believe in the “you only live once” motto and are ready to splash some cash on an exotic holiday now and worry about it later. Although the 401(k) is also your hard-earned money and you should be able to use them as you think fit, it should be your last option when it comes to covering a debt. It’s in the same category with a second mortgage on your home.
When is a 401(k) a good idea?
Borrowing from your future self can help you get some breathing room and settle your debt. However, if you are not careful, you could spend the newly found cash without covering any obligations, thus swirling deeper into debt.
As a rule of thumb, this should be your last option, after you tried everything else and you still can’t find any breathing room. For example, if you want to close a credit card with a very high-interest rate, this could be an excellent option for you.
Yet, this loan has some perks that shouldn’t be overlooked. First of all, you are borrowing from yourself so that you can expect the lowest interest rate. Next, you can set up automatic repayments directly from your paycheck to never miss a payment. Even if you prefer to make the reimbursements yourself and are a few days late, you don’t risk damaging your credit score. When you act as your lender, it makes no sense to report yourself to credit bureaus.
What are the risks?
The main risks are related to paying penalties if you lose your job or quit while the balance is still outstanding. The remaining part is reported to the IRS as an early pension distribution. This process makes you liable for tax and 10% penalty if under 59 ½.
What are the other options?
The most important thing when struggling with debt is to think outside the box and try to find solutions instead of focusing on the problems. Possible strategies include:
- Using a card with a lower interest rate. Before you go into pension savings, if you want to cover a debt with a high-interest rate, as long as your credit score allows you, open a card with lower interest and use it to pay your liabilities. If you have some trouble with your credit score you could first try to fix that, by asking the help of professionals like Credit Repair Companies.
- Get a second job or at least a part-time gig. Think about what you are good at and could bring you money. It could be anything from online freelance jobs to babysitting, tutoring or gardening. Don’t be afraid to turn a hobby into a lucrative engagement.
- Have a yard sale. You might not think about it, but you have thousands of dollars’ worth of things just lying around your home, gathering dust. Be less emotional and turn them into dollars fast.
If you decide to go ahead and take the loan, after you pay it in full make a strategic move. Keep the monthly payment, but redirect it to a savings account to start your money cushion.