There is a sense of panic when you can’t find any debt solutions and you see the numbers rising month after month. After trying to pay down your credit debt on a high interest account you may turn to finding ways to borrow just to pay off that crushing debt.
The first desperate measure many people choose is to take a second mortgage on their home. By taking cash out of the equity of their home, they will be able to pay off the high interest credit card. This is an option that rarely has a good outcome.
Unless the cards are hidden away or the credit accounts canceled, it’s easy to find yourself with a second mortgage to pay and more credit card debt. You are risking a valuable resource – your home, but without a plan to avoid credit debt in the future you are only digging a deeper hole of financial problems.
Borrowing From Yourself
Another common practice is to borrow money from your own pocket in order to pay off crushing debts. The 401K plan is a retirement savings that many of us contribute to through our employers.
A regular amount is taken from our salary (before taxes) each payday and deposited into our 401K retirement account. Many employers also contribute a share by adding a percentage of what we deposit and thus helping our retirements funds grow. The money in our 401K is invested in stocks, bonds or other financial instruments we choose.
It’s tempting to look at that healthy dollar amount in your 401k and realize that you can borrow from it at a low interest rate and repay yourself! Sounds like a smart idea, doesn’t it? If you are young and see retirement income as something in the distant future, this might be an option.
The question of whether to use your 401k requires knowledge of your own spending habits. If you know that you can’t resist a deal and if you have no intention of stopping your use of credit cards, you might be risking your future for a quick fix.
Do Not Cash in The 401K if You Are Young
Cashing in the 401K should not be one of your debt solutions when you are young as there are penalties that can take a good part of the funds as fees. Borrowing from your 401K doesn’t carry those penalties but that money that was “pre tax” may become taxable in the year you take it out.
Pulling money from your retirement account to pay debt may be a good solution if the debt was something you couldn’t avoid. This might be the cost of emergency medical treatments or the need to furnish your first home or perhaps you had to pay for regular expenses with credit when you were laid off for several months by your employer.
Repaying the 401K will be faster due to the lower interest rates and you will be paying interest to yourself. The downside is that you will miss opportunities for your money to grow in investments during the time it is used as a loan.
Using Your 401K as Collateral For a Personal Loan
Another alternative may be to use your 401k as collateral for a personal loan at your bank. You are still swapping debt for debt but you may be able to get a better interest rate on a loan than you have on your credit cards and also have a rate that is fixed.
With this method you are solving your credit debt problem and using your 401K to your benefit without taking money from it.
If you have a 401k with a healthy amount of money in it, this might be a useful method to pay off high interest credit card debt. However, before raiding your retirement account make a plan for staying out of credit card debt before doing anything else.
It will not help to use your 401k as one of your debt elimination strategies if you then create more debt. With other words, do not put yourself into more economical trouble; instead, try to solve the current one’s first.