Should you take out a 401(k) loan to consolidate credit card debt?


If you’ve been waiting to get out of your credit card debts fast, then there is an easy solution for you.

What is that?

Borrowing against your retirement plan and using the money to consolidate your debts.

A large number of people are taking resort to debt consolidation options to get rid of their debts.
Some 401(k) plans allow people to borrow loan against their savings. Since the interest rate is relatively low, people prefer to take out a loan against their retirement savings to consolidate their higher interest rate debts.

Is it good to borrow against the retirement account to consolidate debts?

When you ask the financial experts about the prospects of borrowing against their retirement accounts, they have a mixed opinion.

While some say it is fine to pay off your high-interest debts by taking money from your retirement account, others say that it should be avoided.

They suggest that borrowing a loan against the retirement account should be the last option.

Have a look at the pros and cons of taking out a 401(k) loan for repaying your debts.

Why should you borrow from your 401(k)?

If you’re considering the option of borrowing against your retirement plan, here are some benefits that you may take into account.

  • > As it is your money that you’ve been accumulating in your retirement account, borrowing against it means borrowing from yourself and also repaying yourself.
  • > In most cases, it is seen that borrowing against your retirement plan is much easier than taking out any other unsecured loan to repay your debts.
  • > If you borrow from your retirement account, you will easily be able to repay the high-interest debts that would otherwise continue to bar you from seeking financial security.
  • > There is no negative impact on credit score.

Why shouldn’t you borrow from your 401(k)?

Only considering the benefits of borrowing from your retirement account will not be enough. You also have to take into account the downsides of it so that you can make a measured financial decision. Here are some of them.

As you’re removing the money from your retirement account, you’re actually losing the ability to make more money. This lack of growth opportunity for your money must be considered before taking the plunge.

Sometimes, you may even be charged penalty and fees for withdrawing money from a long-term investment tool. If such is the case with you, you better consider some other option.

When borrowing a loan against 401(k) is a good idea

It is true that borrowing from your 401(k) isn’t a smart move. It is because, you have made an investment, which should sit untouched for decades so that the money can grow, and eventually, you can get the benefit when you retire.

So, it is better to avoid borrowing money against your retirement savings.

But here are some situations when a 401(k) loan can be a good option for you.

  1. 1. To get rid of the highest interest rate debts

    When you have no other option to pay off your highest interest debt, then you can consider a 401(k) loan to get out of debt.

    The interest rate is likely lower than the rate on other loans.

    But, the big risk is the possibility of losing your job and having to pay the entire 401(k) loan balance within 60 days. If that happens and you’re unable to pay it back, then the remaining balance will be taxed and you have to pay 10% as a penalty.

  2. 2. To overcome a financial emergency

    If any uncertain emergency arises and you have to arrange a big amount to overcome the situation, then you can take out a 401(k) loan.

    Taking out 401(k) loan for repaying your debt is a quick process. You can get the loan with a few clicks online.

    You can even get the loan with a bad credit history. Your credit history will not be checked.

    However, you shouldn’t always use your 401(k) fund to overcome your financial emergency. You should build up an emergency fund to fight with emergencies.

What are the other options you can consider to pay off debts instead of using 401(k) loan?

If you are unable to pay off your debts and there is no option, then only paying off high-interest debt with a 401(k) is advisable.

There are some other good options you can consider instead of taking out a 401(k) loan.

Here you go:

a. Consider a financial checkup before taking out 401(k) loan

Before taking out a 401(k) loan for repaying your debts, see if you have savings that you can put toward debt. For example,

  • # You can cut down extra costs.
  • # You can also join a part-time job to earn extra money.
  • # Ask yourself whether or not all the expenses are important.
  • # Follow a budget so that you can pay your credit card bills in full and within time.

It will help you set aside money. Thus you can use it to pay off your debts instead of taking out a 401(K) loan.

Remember, you have to find out where the credit card debt is coming from. This will help you to avoid the same issue again later in the future.

b. Seek professional debt relief service

An effective debt consolidation program can help you to get out of debts within a few years.
If you think that the total outstanding balance is more than half of your income and you can’t pay even after a decade, then you should seek professional debt relief service before taking out a 401(k) loan.

Attend a credit counseling session to know about the best debt relief option for you.

You can either consider debt consolidation or settlement.

But if your income is not good and you have other debts, then you may have to consider bankruptcy.

c. You can consider 0% balance transfer card

If you have a good credit score, you can consider a balance transfer credit card with an introductory no-interest period. However, you should have a good income. Also, make sure you pay off the balance within the time.

d. You can take out a consolidation loan

You can pay off your debts by taking out a consolidation loan. If your credit score and income is good, you can get a debt consolidation loan with a lower interest rate.

Finally, remember, all these options are better to pay off debts than taking out a loan against your retirement account. While there are some advantages of borrowing from your retirement account, there are some financial experts who will always say that it should be avoided.

They warn before borrowing money from your retirement account and using it for paying off debts, always consider the alternatives. Dealing with a financial mess can be tough but borrowing money from a wrong source can result in further problems.

As per the financial experts, if you have to take out the 401(k) loan, then make sure you start making contributions after repaying the loan.

Remember, you should contribute enough money to catch the company match offered by your employer.

Make sure you can repay the loan in a short period such as 1 year or less. To do so, try to take out a small loan amount.

Lastly, try not to fall into credit card debt again. Otherwise, you will not be able to secure your financial future (retirement).