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Advice on Paying Off Credit Cards with a 401K Withdrawal

Is it wise to make a premature withdrawal from a 401k plan to pay off credit card debt?

Bill, I have a credit card question: Last year, my husband and I proactively moved to a different state with new jobs to avoid a strong possibility that he would become unemployed, which would have been financially devastating to us. This was a smart move, however moving costs amounted to about 7K which is all on a previously 0 balance credit card (5.9% fixed rate). We are 37 years old making 120K/year and are both saving for retirement. I would really like to pay off the 7K as this is our only debt besides mortgage and cars. We have several old 401k accounts from old jobs, totalling 40K. I would like to take the 7K from one of them prematurely to pay off this moving debt. Don't you think we have enough time to recover for retirement and the psychological benefit is worth the penalty?

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Bill's Answer
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This is really a relative return question... but most likely you are best off not touching your 401k.

You'll be better off refinancing your mortgage or getting a home equity line of credit to get the $7,000 to pay off your credit card debt. You really want to avoid touching your 401K balance. Although it may be harder in the short term to deal with the $7K credit card debt, you'll be in a much better position long term if you allow your 401K balance to continue to grow with all of its tax advantages.

If you refinance your home, you will be swapping high interest credit card debt for lower interest mortgage debt -- and the interest is tax deductible, so the effective rate is MUCH lower.

Now, if you are under the qualifying age (not in retirement) and you liquidate your 401k - you will have a huge penalty, and pay a large penalty in taxes... so the effective cost of that capital is really high.

BUT - you could take out a loan secured by your 401k at a really low rate. That would be better than the penalty taxes of taking money from your 401k.

I hope that helps.

Best,

Bill

www.bills.com/

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  • BA
    Jun, 2010
    Bill
    Tiffany, you have several options. The best is probably to try again and convince them to put you on their "hardship program" and allow you to pay the debt off at a reduced interest rate. You can do this yourself, or you can try to enroll in either a debt management plan with a credit counseling firm or to use a 3rd party service like DebtGoal to help you negotiate your interest rates down (www.debtgoal.com). If you struggle to keep up, I would guess that they'd become very accomodative if you missed a payment or two -- but that would hurt your credit score and you would incur late fees and overlimit fees... so be wary of this approach. Lastly, you can certainly apply for a zero balance or low balance credit card to balance transfer the current balance towards... but these usually have significant upfront fees (1%-5% frequently), so free is not necessarily free. You are smart, however, to get active about getting the debt paid off quickly. Paying 29.99% interest will be very expensive and take a long time unless you can find a way to lump sum pay it off. Lastly, if you own a home (you are only 24, so I suspect this may not be the case) you could try to apply for a refinance debt consolidation loan, or a home equity line of credit. Good luck and please report back on how it goes! Bills.com
    0 Votes

  • 35x35
    Jun, 2010
    Tiffany
    Hi, I am 24 yrs old. My interest rate just increased to 29.99% on one of my credit cards with a $4,000 balance. I have in payoff mode to may it off in Nov when it was previously a 9.99% interest rate. I refuse to give this credit card company 30% interest; I have tried several times for them to reduce it but still no luck. I have been considering all options as follows: opening up another credit card with no interest for 6 mos on balance transfers, taking out a loan with lower interest rate, taking the $4K out of my 401K but increasing my contribution to be equivalent to me paying the monthly credit card bill of $300. I am confused on which route to go so I need help from a financial advisor to help me understand which option is best. Please help.
    0 Votes

  • BA
    Nov, 2008
    Bill
    Unfortunately, refinancing is probably going to be very difficult right now due to the problems facing the U.S. housing and credit markets. While consumers with good credit and down payments are still able to find loans (in some cases), your debt to income ratio will likely be a serious hurdle to refinancing. Also, a debt management program is likely to lower your wife's credit score, which would make refinancing your home that much more difficult. I honestly think that the best thing that you could do right now would be to consult with an experienced bankruptcy attorney in your area. Visit http://www.bills.com/bankruptcy/ to read more about bankruptcy. If you and your wife file for Chapter 7 bankruptcy, you may be able to discharge all of your unsecured debts, freeing up a large amount of money each month which you can apply to your increasing house payments (due to the jump in the interest rate) until the credit markets improve and you can refinance. While a bankruptcy will certainly make refinancing more difficult, if you work on improving your credit rating over the 3-4 years following the bankruptcy, your credit will have hopefully recovered enough to refinance into a more favorable home loan.
    0 Votes

  • JD
    Nov, 2008
    james
    I have large debt problem. Between me and my girlfriend we have acumulated about 30,000 over last two years in credit card debt. She was off work the first year with newborn son, and second year in school for medical billing and coding. Shes finishing her extership in one more month and will return to work in january. Problem is even after she returns to work we still wont be able to pay for all the new debt. She has 15,000 in debt with one card defaulted 29% for last 10 months. The other is 10,000 at 13%. We are in the process of getting her in to debt management program. I am also concidering but dont know if I will have harder time refinaceing house if im in program. I already have been denied refi in march and have more debt now. have debt to income ratio problem, too much risk. In april arms loan expires and did not know about convertion option at time of loan, first time home buyer. The % rate can/will go up 2 more %. With realastate values dropped there is know equity to borrow from to help. All have is about 13,000 in 401k fully vested,9,000/10,000 suv and a boat worth about 2,000. bad time to sell boat in middle of winter but all must go.I owe about 5000 left on the truck that was on a card 0% One year thats expiring this month to 11%. I also know have a defaulted card 4000 at 22% and into rates on the other debt is also going to expire. were do I begin.!!! should I also take the 401k tohelp fix my credit so maybe I will be able to refinace, I will only get about 7-8000 but despritly need to lower debt and payments. I will still need to buy junk vehicle with something. Ive talked to credit debt company and not sure if advise is sales pitch. Im 30 and wow what a mess , but I could with the new job in union,with great retirement,recover the small loss. Does seem to be the right decision. cant sleep need help
    0 Votes

  • BA
    Aug, 2008
    Bill
    One good option that most of the plans provide is to take out secured loan against the 401k plan. Also, you can make a hardship based withdrawal, the IRS specifies as to what qualifies as a hardship and you will need documented evidence to prove the hardship. Contact your plan administrator for more details.
    0 Votes

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