401K Borrowing: Ever even an OK Idea?

August 2, 2007 5:55 AM

I have tons of debt and am just not getting ahead nor falling behind, either, but.... I'd like to use my 401K to solve this problem. Of course, there's

I have a house that, due to the slightly declining market and the fact that I had no down payment when I bought it a couple of years ago (seemed like a good idea at the time), has zero available equity and a fairly large monthly mortgage payment. I also have lots of credit card debt, which would be nearly completely wiped out by taking $50K out of my 401K. The credit cards that would be paid off would constitute about $1200/month in payments that could be exchanged for (what I assume would be) lower payments back into the 401K, including the fact that I would be paying myself the interest, even though it is after taxes. I know that borrowing against your 401K is never advised, but I feel my situation may make that knee-jerk reaction a little too hasty. I believe if I were out from under the mountain of credit card debt, I'd be able to refinance my mortgage and get it cut by nearly $500 pretty easily.

Anyone been in a similar situation? Anyone done the 401K borrowing where it worked out well? Any other inventive solutions you can think of?

Thanks, Hive Mind!!

posted by anonymous to work & money (8 comments total)

I've borrowed against my 401k - not as much as 50k, but like you said, you're paying yourself back, and if the interest you're paying yourself back + taxes is going to be less than what you're paying on the credit card, I'd do it. Keep in mind most 401ks usually have a timeline for when the loan has to be paid back (like, 2 years, maybe more), and a limit to how much you can borrow (in my case, it's up to 50%) and also if you lose your job, you will have to either restore all that money or take an ass-pounding when it comes to taxes, not to mention poof, there goes your retirement.

If you can model how much will be taken out of your paycheck each month with the interest paid, and compare it to your credit card debt, I'd do it. I am not your financial advisor.
posted by mckenney at 6:15 AM on August 2, 2007

The problem with borrowing to paydown debt is that you end up with two debts after you run up the cards again. In addition, you are taking a more secured loan (against cash you actually have) to pay off a totally unsecured loan (credit cards). From a very quick google, it looks like 401k's and such can't be bankruptcy'd away from you, although I'd check on that.

It's horrible for your credit rating, but at the point you're at, it might make sense to walk away from your mortgage, and declare bankrupcy. It'll require living differently, and if you make more than the median income, it's hard to have your debts wiped out, but you can restructure and make them livable.

Please don't borrow from the only cash stockpile you have, the one that will keep you from eating ramen in old age. There are other ways of dealing with massive debt, the best one being the "cut everything out of your life and pay it" method. Read some financial blogs and get a feel for how people are paying off their debts.

One last idea, call up the credit card companies and tell them that you are making one last go at paying before bankruptcy and if they lower your rate, it's more likely they'll get their money.
posted by cschneid at 6:38 AM on August 2, 2007 [1 favorite]

I hope you're young, because my advice will kill anyone over 35.

You've got debt problems. Borrowing from yourself doesn't solve the debt problems.

That's why I recommend raiding--not borrowing--raiding your 401k. Take the money, pay the penalty and taxes, and "retire" your debt. Don't fool yourself into thinking you'll pay it back. You won't. Believe me, you won't.

Everyone will say this is bad advice. Think it through, review the consequences. It sure beats losing your house.

That said, if you have zero equity in your house, you have nothing to lose. Ditch the house and find a rental in your range.

Don't let the bank foreclose. It's bad for you and the banks hate it. Try to sell the house. Remember you're not trying to make a profit, you're trying to cover a nut.

If you can't sell, talk to the bank. You won't be the first person they've seen with your problems. You may be surprised at how flexible the can be when they are staring down the costs and hassles of foreclosure. If the're not flexible, you could hand them the keys and say you'll be moved out in a week. You've avoided foreclosure and bankruptcy.
posted by GarageWine at 7:21 AM on August 2, 2007

I just did what GarageWine advised. I didn't have CC debt, but rather was dealing with some student loan debt that I had defaulted on a few years ago. Even though I've been making regular payments for three years, the interest and penalties were killing me and I wasn't making a dent in the principle. So, I negotiated with my student loan company for a pay off deal which was $15000 less than what I owed, and took out the majority of my 401k to pay it off. I took out enough to pay for the loan and the taxes+penalty that I will have to pay next year (I have that extra money sitting in a high yield savings account until tax time). I may also be able to get around paying the 10% penalty since I used the money for higher education costs, but my accountant will have to investigate this.

Even taking the hit for taxes and penalties (9k), I come out ahead because they knocked $15k off what I owed. I can't tell you how much better I feel... it was like a load was lifted. And now I can afford to double what I was putting in my 401k before I made this decision.
posted by kimdog at 7:34 AM on August 2, 2007 [1 favorite]

The problem with painless and low-pain solutions is that they rarely force people to change. As cschneid says, the majority of people just run the debt up again.

Here's the big litmus test question in my opinion: have you lived exclusively on cash these last six months or have you incurred new debt?

If you've incurred new debt - and "I had no other choice if I wanted to keep eating" doesn't change the meaning of the answer - then you're not going to be successful with any flavor of refinancing, which borrowing from your own 401k qualifies as. Don't even bother, all you'll do is surrender that judgment-proof retirement savings to the inevitable crash.

If you have an income you'd be best served going to a reputable credit counseling service. They'll work out a deal with your creditors, potentially including partial payment, and get you on the road to recovery. It'll require you to cancel all your cards and change the way you live but quite frankly it's obvious that's exactly what you need anyway.
posted by phearlez at 10:59 AM on August 2, 2007

I believe if I were out from under the mountain of credit card debt, I'd be able to refinance my mortgage and get it cut by nearly $500 pretty easily.

I don't know if you've been following the whole "housing bubble bursts" stories in the media lately, a.k.a. the "subprime meltdown", but a number of very well-known mortgage companies (Countrywide, Wells Fargo, AHM, etc.) have either gone under or have suspended all stated-income loans and many types of previously-available interest-only loans. Lending requirements are being tightened up everywhere. Some of these new policies have only started going into effect in literally the past few days, and it is quickly spreading to more mortgage companies and banks.

Furthermore, you can only refinance at what the current value of your house is, and if you check out home prices in your area -- prices that comprable homes have sold for recently, not what they're listed for -- the price may have dropped quite a lot since a year or two ago (it has in most areas), which reduces how much equity you can pull out.

Finally, if you do refinance, please please please make sure it's a fixed rate mortgage and it's not a teaser rate for five years that adjusts later based on the interest rate, and that it doesn't have a add-on-to-the-end balloon payment, or anything like that. A lot of people are getting hurt by getting in over their heads.

Which is why I have to echo GarageWine's advice here: you may need to be prepared to walk away from your house and take a loss, rather than risk a foreclosure on your record.
posted by Asparagirl at 11:03 AM on August 2, 2007

It's only an okay idea IF you don't generate new credit card debt. Analyse how you got into the debt, and be really honest about your ability to stay debt-free. Otherwise, you've just tied up your retirement.

There are several great blogs on paying down debt.
posted by theora55 at 12:09 PM on August 2, 2007

I was recently in a similar situation. Granted.. I dont own a house (actually, i dont own much of anything)... I had 25k in CC debt.. and about 10k in a 401k.

I paid the penalty.. and cashed out my 401k.. (of which I got around $7500).. sent that to my credit cards.. and in the mean time moved into my brothers basement (free rent!).. and am now working 3 jobs to pay the rest down. I currently have around $4000 in my checking, which I'm going to send more to my CC's.. and keep attacking them till they are paid off. (conceivably I can live here under free rent till the end of the year - brother owes me :P... )

for the record.. I'm 34.. ... maybe not the wisest choice to cash out my 401k.. but i think for my situation, given that it will help me recover from CC debt faster.. I think its my best option.
posted by jmnugent at 6:50 PM on August 2, 2007