Would this be a bad financial decision

[Deeko]

So here's the deal...throughout college I aquired about $3000 in credit card debt, mostly through car problems (my car was a piece of crap but I needed it, basically). This isn't a huge amount of debt, but since it was a student card, the interest rate is ridiculous, I think like 31% APR.

I have $4000 so far in my 401k. I could borrow $3000 from that, pay off the credit card, and pay myself back in 12 months. The hit to may paycheck would be less than that of paying off the credit cards in that amount of time, because the 8.5% interest rate is far less. With the stock market kinda crappy right now, that rate would probably be better than my investments right now anyway.

The drawback is if you lose your job, you owe it all up front. Well, I work for a pretty big, stable company, so unless I leave on my own, my job isn't going anywhere in the next year.

I read everywhere that loans from your 401k are a bad idea, but the drawbacks are the lower interest rate vs market returns, and the risk of losing your job. Considering its short term, and it would be to counteract a very high interest rate, I think in this situation it might be a good solution.

Thoughts?

 

[BrunoPuntzJones]

And you get a tax penalty possibly.

Just get an unsecured loan from a bank, 3k ain't much of a big deal. Shouldn't run 10%

 

[maddogchen]

balance transfer it to a credit card with 0% APR for 12 months and pay that off?

 

[vi edit]

Originally posted by: maddogchen
balance transfer it to a credit card with 0% APR for 12 months and pay that off?

Good call.

As for the withdrawal penalty - if he has a loan policy in his 401k plan then there are no penalties.

 

[MyThirdEye]

Originally posted by: maddogchen
balance transfer it to a credit card with 0% APR for 12 months and pay that off?

Go with that option.

 

[Uppsala9496]

You won't pay any 401k early withdrawl penalties as long as you pay off the loan during the term of the loan. If you don't then you are hit with the 10% early withdrawl penalty along with the 20% taxable income on it.

I've borrowed on my 401k in the past when it made more financial sense to do so than taking out a loan from the bank.

 

[FoBoT]

it is an excellent idea (8.5% < 31% ) if you don't aquire new CC debt after you pay it off

there are no tax penalties for borrowing from your 401(k) , I have done it a couple time the last few years

just cut up your CC's and don't use them, don't get new CC's while you pay off the loan

 

[Deeko]

As uppsala said, I only pay the early withdrawl/taxes if I don't pay it off in time (or don't pay it all back should I lose my job). Getting a new credit card with 0% would be one solution, but that is contingent on my opening a new card with a high enough limit, which I'd rather not do. Its another open account, and its another inquiry on my credit report.

 

[Deeko]

Originally posted by: FoBoT
it is an excellent idea if you don't aquire new CC debt after you pay it off

there are no tax penalties for borrowing from your 401(k) , I have done it a couple time the last few years

just cut up your CC's and don't use them, don't get new CC's while you pay off the loan

Yea I haven't used the card in awhile, and definitely don't plan to in the future. It was emergency-only in college, when I didn't have stable income/expenses, and I had an unreliable car prone to breaking. None of those are the case now, and I've got somewhat of a buffer that I didn't have before.

I'm leaning towards doing the loan at the moment.

 

[FP]

I know people who have done exactly what you are talking about and it worked out for them.

The upside for them was it was during the tech bubble bursting so they actually saved money by doing it.

 

[FoBoT]

if your credit is really good, the moving to another card thing is better, but i don't think you'd be paying 31% if you had good credit. the 401(k) loan thing can be good for people with bad credit since the account is the collateral

good luck OP :sun:

 

[Deeko]

My credit score is good, but my history is limited cuz I'm still pretty young. The card in question has such a high interest rate because it was a student card, I opened it when I had no credit at all. I did open a regular card last year with a much better interest rate, but because of my short history they gave me a pretty low limit to start.

Plus, when I move out of my apartment in the 2nd half of 2008, ideally I'll be buying a house, so I want my score as high as possible by then (which means as little credit card debt and as few inquiries as possible).

Thanks for your help.

 

[PokerGuy]

Borrowing from your 401(k) might seem attractive, but there's a hidden reason why you should use it *only* as a last resort. In addtion to the other caveats already mentioned, when you borrow from your 401(k) you are agreeing to pay taxes TWICE on the amount you borrow.

Lets say you borrow $3000 from the 401(k) plan. You don't pay a tax penalty as long as you repay it as scheduled. However, the money you use to repay the amount (including interest) is paid for using money that's already been taxed (your after-tax income). Then, after you've repaid, when you take the money out of the 401(k) plan at retirement, you're going to pay taxes on that same amount -- again. So you get the double whammy.

 

[DaveSimmons]

Originally posted by: PokerGuy
Borrowing from your 401(k) might seem attractive, but there's a hidden reason why you should use it *only* as a last resort. In addtion to the other caveats already mentioned, when you borrow from your 401(k) you are agreeing to pay taxes TWICE on the amount you borrow.

Lets say you borrow $3000 from the 401(k) plan. You don't pay a tax penalty as long as you repay it as scheduled. However, the money you use to repay the amount (including interest) is paid for using money that's already been taxed (your after-tax income). Then, after you've repaid, when you take the money out of the 401(k) plan at retirement, you're going to pay taxes on that same amount -- again. So you get the double whammy.

I don't think you're correct.

A: leave contributions in 401k
- 401k gains value
- $3K plus interest (say $4K) of after-tax income paid to CC company

B: get loan
- 401k stops growing while money is gone
- $3K from 401k goes to CC company
- $3K of after-tax income goes to 401k to repay it.

Either way that $4-3K was after-tax income spent to repay something. The difference is that the CC is charging 31% interest while you lose (say) 10% in stock market gains in the 401k.

 

[D1gger]

Originally posted by: PokerGuy
Borrowing from your 401(k) might seem attractive, but there's a hidden reason why you should use it *only* as a last resort. In addtion to the other caveats already mentioned, when you borrow from your 401(k) you are agreeing to pay taxes TWICE on the amount you borrow.

Lets say you borrow $3000 from the 401(k) plan. You don't pay a tax penalty as long as you repay it as scheduled. However, the money you use to repay the amount (including interest) is paid for using money that's already been taxed (your after-tax income). Then, after you've repaid, when you take the money out of the 401(k) plan at retirement, you're going to pay taxes on that same amount -- again. So you get the double whammy.

There is no difference between getting a normal bank loan, and repaying that with after tax dollars, paying his credit card debt with after tax dollars, or repaying his 401(k) loan with after tax dollars. They all result in debt repayment with after tax dollars, and when the 401(k) is used in retirement the withdrawals are taxed. The only difference here is the availability of a normal bank loan and the interest rate charged on the existing credit card. In the OP's situation, it makes perfect sense to take the 401(k) loan.

 

[FoBoT]

yeah, the debt has to be paid with after tax dollars no matter who it is paid to

 

[Chryso]

Originally posted by: Deeko
As uppsala said, I only pay the early withdrawl/taxes if I don't pay it off in time (or don't pay it all back should I lose my job). Getting a new credit card with 0% would be one solution, but that is contingent on my opening a new card with a high enough limit, which I'd rather not do. Its another open account, and its another inquiry on my credit report.

The balance transfer is the best solution. The excessive worrying about credit scores is equivalent to wearing a tinfoil hat to stop the government from reading your thoughts.

 

[Deeko]

Originally posted by: Chryso

Originally posted by: Deeko
As uppsala said, I only pay the early withdrawl/taxes if I don't pay it off in time (or don't pay it all back should I lose my job). Getting a new credit card with 0% would be one solution, but that is contingent on my opening a new card with a high enough limit, which I'd rather not do. Its another open account, and its another inquiry on my credit report.

The balance transfer is the best solution. The excessive worrying about credit scores is equivalent to wearing a tinfoil hat to stop the government from reading your thoughts.

I don't worry about my credit report excessively, just right now because I'll be applying for my first mortgage soon.

 

[CPA]

Most of what is stated by vi_edit and fobot (and others) is correct, so I only have one question: What 401K plan will allow you to borrow 75% of it's value? Most only allow 50%. Furthermore, if the $4K balance has any Employer Contributions, are those fully vested? You can't borrow against unvested balances.