Frugal Living, Saving Money & Life Hacks

Using A 401k Loan To Pay Off Credit Cards (Hint: Don’t Do It!)

Kimberly Studdard August 12, 2022 get out of debt, money

If you have quite a bit of high-interest debt, you may be looking into ways to pay it off faster. But if you’re considering using a 401k loan to pay off credit cards, you should know a few things first (plus why we don’t recommend you do it!).

Can I take a loan out of my 401k to pay off my credit card debt?

Technically, yes.

Many different 401(k) plans allow you to borrow against your retirement savings. One of the benefits to many people is that it’s a low-interest loan option and will make it easier to pay it back vs. high-interest credit cards.

Can you use a 401k loan for anything?

Yes.

A 401k loan works like a personal loan. Once you receive the money, you can use it for virtually anything.

Is it smart to borrow from 401k to pay off debt?

Here’s the big question….”Should you borrow from a 401k to pay off debt?”

We don’t think so.

Not only does it take money from your retirement, but it also must be paid back, usually with interest. Why pay back what you’ve already saved?

Also, have you considered this?

What happens if you leave your job and you have a 401k loan?

Per the Tax Cuts and Jobs Act that was passed in 2017, if you leave or are exited from your job, you owe back your entire loan amount to your 401k by your tax return date (likely April 15th of the following year). That’s not much time to pay back tens of thousands of dollars…!!

If you default on your 401k loan, you will be taxed on the withdrawal (just like if it were income), and if you’re younger than 59.5 years old, you’ll be charged a 10{6f482cd57796f86e9ad1be82bcf1dcf19049bb2b279893497447a8f8ed9023fd} penalty for the early withdrawal.

Seems like the 401k loan is a fairly risky option… However, if you don’t have any other option for paying back debt and can’t get a personal loan or debt consolidation, a 401k loan is a lower-cost option vs. drowning in credit card debt. While we don’t recommend it, sometimes you have to do what you have to do.

What reasons can you withdraw from 401k without penalty?

There are a few exceptions that you can withdraw from your 401k without penalty.

They include:

Unreimbursed medical bills
Owing the IRS
Disability
First-time homebuying
Higher education expenses
Hardship

These will of course depend on your specific 401k plan and its rules.

Does credit card debt qualify for 401k hardship withdrawal?

Maybe.

First, not all plans 401k plans allow for hardship withdrawals. And even if yours does, it will depend on your employer’s discretion. They may or may not consider it a hardship withdrawal, and you’ll be responsible for penalties and fees if they don’t.

Can you be denied a hardship withdrawal?

Yes, your 401k plan can deny you at any point if you’re trying to withdraw a 401k loan.

Does a 401k loan affect your credit score?

Technically, a 401k loan isn’t debt. Because it’s your money, withdrawing from your 401k has no effect on your credit score.

But, if you apply for a mortgage soon after a 401k loan, they may ask if you’ve ever borrowed against your 401k, and you’ll need to answer honestly.

What is the max 401k loan?

Usually, the maximum amount you may take is 50{6f482cd57796f86e9ad1be82bcf1dcf19049bb2b279893497447a8f8ed9023fd} of your vested account balance, or $50,000, whichever is less. For example, if you have a vested account balance of $20,000, you may borrow up to $10,000.

Your maximum withdrawal is $50,000.

What is the best way to get rid of credit card debt?

Let’s say we’ve talked you out of borrowing against your 401k. If you’re still looking for help getting out of credit card debt, keep on reading!

These are our best tips for getting out of credit card debt!

1) Focus On High-Interest Rates First

First, focus on your highest interest rate credit cards. These are the accounts that are eating up the most of your money due to their rates. You should follow a snowball-type system but focus on rates instead of amounts.

While paying off the cards with the highest rates, only pay the minimum on the other cards. Yes, this will mean you’re raising more debt due to interest. But that was already happening. By focusing on what’s making the biggest dent in your wallet and paying that off first, you can eliminate debt faster.

2) Double Your Payments

Can you make extra payments to your credit card if it’s the main debt you’re focused on? This will most likely require gazelle intensity and eliminating “fun” or spending money while you’re paying it off. But think about it this way… short-term sacrifice for long-term gain.

If you can double your payments (or just throw extra money at debt in general!), you can pay it off faster.

3) Put Extra Money Towards Debt

Get a windfall? A bonus? Tax refund higher than you expected? Throw it towards your credit card debt.
Aunt Marge give you $100? Throw it towards debt.
Side hustling and made quite a bit this week? Throw it towards your debt.

Any amount you can throw to your credit card debt gets you closer to paying it off in full. Remember, the more you can pay, the faster it gets paid off.

4) Negotiate With Your Credit Card Company

If you’re doing everything you can to pay off your credit card debt, but it still seems to be racking up or lowering slowly, try negotiating the rate with your credit card company.

Be respectful and showcase all of your positives.

Have you always paid your minimum on time?
Have you been paying it off regularly?
Is the debt lowering?

Anything that can benefit you, mention it.

Many credit card companies will lower your rate (temporarily or permanently) to keep your money and your business. And even if they aren’t willing to do that, at least you tried. Now you can move on to another option.

5) Transfer To A New Card

If you’ve tried to negotiate your interest rate with your current company and got turned down, there is another way to lower your rate.

If you have a decent credit score, and your credit card isn’t maxed out (or isn’t too high, ie. $50,000+ in debt), you can always try a transfer.

How does a credit card balance transfer work?

A balance transfer is fairly simple — you move your debt from one account to another. This is especially helpful if you can move your debt to a credit card offering a 0{6f482cd57796f86e9ad1be82bcf1dcf19049bb2b279893497447a8f8ed9023fd} introductory APR on balance transfers. Many offer the 0{6f482cd57796f86e9ad1be82bcf1dcf19049bb2b279893497447a8f8ed9023fd} interest rate for 12-18 months, giving you plenty of time to pay off the card before you’re charged!

Keep in mind that balance transfers come with certain costs and limitations. You’ll usually have to pay a balance transfer fee. This can be anywhere from 3{6f482cd57796f86e9ad1be82bcf1dcf19049bb2b279893497447a8f8ed9023fd} to 5{6f482cd57796f86e9ad1be82bcf1dcf19049bb2b279893497447a8f8ed9023fd} of the total transferred. And if your balance transfer card’s limit is low, you may not be able to transfer your full balance.

So make sure you have enough money to pay the balance transfer fee and try to get approved for the full amount you owe to avoid the headache of transferring to many different cards.

6) Look Into Debt Consolidation

If you have too many high-interest rate credit cards, debt consolidation is another option instead of a 401k loan. Again, not an ideal solution, but it is an option.

Debt consolidation involves rolling one or multiple debts into another form of financing. This is usually in the form of a personal loan that you pay back monthly. Debt consolidation usually offers a lower APR than what you’re currently paying — helping you pay off the debt faster and pay less interest.

While there are many debt consolidation options, we recommend choosing a trusted company. We recommend LightStream, SoFi, and Upstart.

Should You Use A 401k Loan To Pay Off Credit Cards? No!

Using a 401k loan to pay off credit cards often isn’t the wisest choice, even if it does offer a low-interest payback option.

Instead, try the other tips we mentioned and see if you can pay off your credit cards, and use a 401k loan as the last resort.

The post Using A 401k Loan To Pay Off Credit Cards (Hint: Don’t Do It!) appeared first on Life And My Finances.

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