The third quarter 2018 financial numbers are in, and they are not pretty. Average credit card debt inched up to $8,284 per household. That’s the highest level in recent memory. Furthermore, this average amount is less than $200 away from an “unsustainable” level. So, most people can probably tread water for a few months. But almost any wave or riptide will drive them underwater. And most of us know that the next financial storm is never more than a few months away. Many folks are tempted to dive off the deep end and borrow against 401(k) to pay off debt.
However, if you are behind on your credit card payments, or if you are just hanging on, there is good news. Yes, late credit card payments will drive down your credit score. But the effect isn’t nearly as bad as things like collections referrals and repossessions. Entries like these indicate that the consumer gave up. So, almost regardless of your situation, you have some .
Choosing to Borrow Against 401(k) to Pay Off Debt
This option is tempting. After all, 401(k) loans usually have extremely low interest rates. Typically, the interest rate is just a point or two above the prime rate, at most. But such a loan is almost always an awful idea, for both financial and non-financial reasons.
First, the financial reasons. Yes, the repayments are practically interest-free. That’s a welcome reprieve for people who are paying 17 percent, which is the average credit card interest rate. But let’s look behind the numbers.
401(k)s have tremendous tax advantages. The contributions are tax-deductible, so you could be in a lower tax bracket. Moreover, you do not pay taxes on the savings until you begin taking disbursements. At that time, your income, and tax bracket, are usually a lot lower than they are when you are working. Taking money out of your 401(k) kills both these advantages.
There is also a significant financial risk. If you lose your job or quit, you must repay the loan in full within ninety days to avoid a tax bill plus a 10 percent early-withdrawal penalty. People who had trouble paying credit card bills probably cannot quickly pay off their 401(k) loans either.
Here are non-financial reasons as well. Your 401(k) is your nest egg. Stress over a lower retirement account balance is just as bad as credit card bill stress. Moreover, if you are going through a divorce, a 401(k) loan makes life extremely complex.
HELOCs to Pay Off Debt
A Home Equity Line Of Credit is a better idea than a 401(k) loan. In fact, in some cases, a HELOC may be just what the doctor ordered. But in other cases, not so much.
HELOC interest rates are usually the same as mortgage interest rates. That usually means three or four points above the prime rate. Additionally, the interest may be tax-deductible, as long as the loan is under $100,000. Try getting either one of those deals from a rewards MasterCard.
Is this approach right for you? Ask yourself why your credit card balances got so high in the first place. Sometimes, credit card debt is beyond our control. For example, people who lose their jobs must usually live off credit cards for a few months. If that’s you, a HELOC may be a good option.
Other times, however, overspending is clearly the culprit. If that’s you, a HELOC just gives you more money to spend recklessly. There’s another factor as well. In general, borrowing money to pay off debt is a rather unsettling prospect.
Chapter 7 or Chapter 13 may be a good option if the debtor faces severe adverse action, like repossession or foreclosure.
But as mentioned, credit card debt is not nearly that bad. In a few states, moneylenders can garnish wages for unpaid credit card debt. However, they must first go through the lawsuit process, and unless the debtor defaults, that process could take months or years.
Debt Counselling/Debt Consolidation
For various reasons, this option is usually the best way to pay off credit card debt. Some possible benefits include:
- Debt counselors can get to the heart of the problem. Most people who go through debt counseling understand why they got into trouble and obtain the tools they need to stay afloat when the next financial storm hits. Of course, the debtor must go into counseling with an open mind and a desire to do better.
- Experienced debt consolidation companies usually have close relationships with major creditors. They can leverage these relationships into income-based settlement plans. Beware of any company that makes big promises or wants a lot of money upfront.
- Notations like “settled account” look a lot better on credit reports than notes like “lawsuit filed” or “referred to collections.” Plus, everything is negotiable. If the price is right, the moneylender often agrees to omit this note.
Financial counselling and assistance from someone who shares your values is even better. The New Testament has more to say about money than almost any other subject.
If you have questions about credit card or other debt, we have answers. You shouldn’t have to consider if you should borrow against 401(k) to pay off debt. Reach out to the trusted staff at Christian Debt Counselors today to begin the settlement process.