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I'm considering taking a loan on my 401k in order to pay off and close 2 credit cards. I have approximately 30 years until I consider retiring. The amount of the loan will be $1700 which is less then 20% of my current 401k balance. I will continue to put 9% of my paycheck into a Roth 401k, and my employer matches 9%. The loan will be paid back at 3.25% (to myself) and does have $183 in fees.

There are 2 cards I will pay off and close if I follow through with this plan. One card is 17.9% interest with roughly a $650 balance. The other is 23% (ish) with roughly a $1,025 balance. Both of these cards do have an annual fee associated with them, I used them to rebuild my credit and have a newer, lower interest, no fee card that I will keep active for emergencies.

Would it be advantageous for me to pay off these two credit cards and cancel them with a 401k loan?

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    A 401(k) loan has historically not been as good a deal as it might appear, after you run all the numbers on its effects. You may actually be better off taking a loan from your bank or credit union. – keshlam Dec 8 '15 at 14:25
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    If you do take this $1700 loan, how fast will you pay it back? – Ben Miller Dec 8 '15 at 14:26
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    The fees alone are already 10% of the principal, I find it hard to imagine that this is the best option you have. – Lilienthal Dec 8 '15 at 15:49
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    @Lilienthal - beautiful. I updated my answer. Even though the fee is 10% over the 2 years, it adds an effective 10% to the annual rate. Wow. – JoeTaxpayer Dec 8 '15 at 16:07
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    Thinking it over a bit more, as small as the balances are even doing a formal balance transfer might not be the cheapest option to move the balance. If you charge and carry $1700 of ordinary living expenses (NOT new spending) on your new card, and use the money that would have otherwise paid for them to pay down your old cars instead. Even on a very limited income this approach should be able to shift the balance over a month or two. If this'd break even is dependent on how much lower the new cards interest rate is, and potentially how soon the old cards annual fees come due again. – Dan Neely Dec 8 '15 at 21:34
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Did you read your own question out loud? Holy cow. Two years to pay off $1700!? Get a part time job, sell some stuff on eBay, and cut your lifestyle. You can be done with this in two months.

Despite the math, you'd be better off to cut your 401(k) contributions to zero until the balances are paid off. That sense of loss of the 9% income will motivate you to get this nonsense cleaned up, and will probably preclude you from borrowing money at 17.9% again.

The course of action you are proposing is not the smartest. In two years, you have a decent chance of being laid off or changing jobs. Once that happens your 401(k) loan is due in 60 days, or it is considered a withdrawal. Tack on another 40% to your loan balance.

You also have to consider the behavior aspect of your plan. If you solve this problem in a painless way will you likely borrow again? Yep. So now you will have a 401(k) loan for $1700 and probably your credit cards will have a similar balance to what they are today.

Still, it was good of you to ask.

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    There's something to be said for 'scared straight' & 'tough love'. There's also a difference between "you have suggested a dumb course of action" and "you are dumb." There's a part of Pete's answer that hit the mark, quite well. – JoeTaxpayer Dec 8 '15 at 15:24
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    +1 for "you might get laid off or change jobs". I got burned by this and a 401k loan - found a great new job a year after making the loan and ended up having to take the loan balance as a withdrawal with all the penalties because I thought I could just keep making payments. It looks like a good option, but has a lot of gotchas. – JPhi1618 Dec 8 '15 at 15:41
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    I'm doing the math and can't quite make it add up. The $1700 plus interest is being paid back into the OP's own 401k, so it seems that all he'll be out after two years is the $183 fee. I understand the point about the potential for being laid off, but I do not understand how he'd be better off – Michael J. Dec 8 '15 at 17:53
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    @MichaelJ. - see my answer for the rest of the math. If he pays in full over 2 years, the saving is minimal. Much to do about nothing. – JoeTaxpayer Dec 8 '15 at 18:03
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    "from borrowing money" - most people do not consider credit cards to be borrowing money. You borrow money with loans, not credit cards. Of course, most people are wrong, naturally, but I think you'd not consider someone with a credit card to consider it like borrowing money. Probably explains why they spend it so easily. – corsiKa Dec 8 '15 at 18:26
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There's a part of me that has to agree with Pete. But his potential solution, cutting your deposits would cost you 100% in the lost match. Where I do agree is that $1700 is a relatively small number. The problem there, is that all the advice, 'sell your crap', 'stop spending on XYZ', 'eat rice and beans twice a week' starts to reflect a laundry list of how to cut expenses. In the end, however, the best advice would be to look at ways to come up with just an extra $150/mo and get rid of this in 6-9 months, tops.

Your choice is actually not the most awful, in 1 year, you'll have paid back half the loan, and your matched deposits will cover the other half should you get let go.

A side note - 401(k) loans are a hot button for many. It's considered a high risk to take in response to past bad behavior. The flip side, is that when I look at the numbers, given a choice between cutting deposits which would be matched dollar for dollar, and taking the loan, the loan wins out.

Back to the numbers - The fee represents nearly 11% of the loan. A bit of math is in order. With the fee added on, $1883 @ 3.25% is $81.14 for 24 months. This is the amount I'd pay on $1700 @13.5% for the same time and payment. In effect, the fee bumps your real rate up to 13.5%. Your 'saving' is less than 10% on average, closer to just $100 over this time. The math actually says "for the sake of just $100 potential savings, don't do it." (Thanks to @Lilienthal for inspiring this paragraph, I wasn't paying much attention to that fee.)

In your situation, there's far more to discuss than this loan. What's the level of your emergency fund? Do you not have $1700 you can take, be done with the cards, and just re-build your savings?

  • In a comment, the OP says that he plans on paying back the 401(k) loan with payments equaling the sum of the minimum payments he is making on his credit card loans (it seems that is all he can afford). Typical minimum payment on a credit card is interest+fees for that month plus 1% of balance due which I calculate to be $16.20+$29.90 = $46.10, roughly half of what you say is the monthly payment on $1883 @3.25% for 24 months. The OP will not be able to pay off the 401(k) loan in two years as he thinks; it will take a lot longer unless he can pay $81 instead of $46 towards the loan. – Dilip Sarwate Dec 8 '15 at 17:59
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    @DilipSarwate my minimum payments are considerably higher then you have calculated, currently between the 2 i'm required to pay about 85 a month. Admittedly these two particular cards are sub prime by far but I've been working diligently to correct what my young self did, which is why I have been able to qualify for a much better card at this point. – rogerdeuce Dec 8 '15 at 18:30
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Interesting. The OP says he is paying roughly $85/month on minimum payment. I'm guessing this splits more or less proportionately - so roughly $52 for the 23% card and $33 for the 17% card. My suggestion would be to leave the 401(k) alone, do a lifestyle survey and see if you can come up with an extra $50 a month (quit going to the bar, reduce the number of channels on your TV or cancel it completely, but pick something that is really achievable and not something that hurts so much you'll give up after two months.) Keep paying the minimum on your 17% card, put the extra $50 to your 23% card. At that rate it will take roughly a year to burn down your 23% card to zero. Then put the entire $135 to your 17% card which you will burn down in 5 months. In those 17 months you will have got 9% matching from your employer...that's significant.

If you can't find $50/month extra, and your credit is good enough to get a better card, you should be able to get a regular bank loan at a rate much lower than your credit card rates. If that's not possible, and since your credit has improved, I presume you've looked at whether you can transfer balances to lower interest rate cards. It's a real mess having the highest balance on the highest rate card!

But whatever course of action you take, burning off $1700 of debt is achievable. But once you've done it cut your cards in half and never, ever spend more on them than you can afford to pay off in a month or two.

Good luck.

  • "your cards in half and never, ever spend more on them...." can't cut them and still use them. – JoeTaxpayer Dec 9 '15 at 13:03
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    @JoeTaxpayer Technically you can still use them online. Just can't use them in person. – Doyle Lewis Dec 9 '15 at 14:26
  • Touché, Doyle. Excellent point. – JoeTaxpayer Dec 9 '15 at 17:01
  • I think these particular cards, knowing that they are sub-prime, aren't exactly meant to be used again regardless – user2813274 Dec 10 '15 at 1:51
  • @JoeTaxpayer Worse yet, the OP can cut his credit cards in half and never use them again, but will still be charged the annual fee unless the credit card accounts are closed in addition to cutting the cards (and destroying all records of their numbers so that they cannot be used on-line). – Dilip Sarwate Dec 10 '15 at 4:49
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It seems we're all assuming that @rogerdeuce is from the United States because he listed his debt in US Dollars. If that is truly the case, it is indeed a very small debt.

I would like to provide a different approach in my answer, as it is something I myself would do in such situation. Ask your parents to help you pay off this debt as soon as possible. If your parents have the money, they will require you to come up with a plan to not let this happen situation occur again.

In many countries, a loan from a family member still requires you pay taxes over it instead of interest, but there's many ways around that if you only word it correctly. You're not asking your parents for a loan: you're asking to split the bill.

To make sure this doesn't happen again you will have to investigate your lifestyle. I myself for example used to get breakfast at the train station five days per week, which was just over €3,- every day. When I started to buy bread from a supermarket to make my own sandwiches I found myself left with a spare €60,- every month. This was only my breakfast; I did the same to my lunch routines and saved another €140,- per month!

In short, ask your parents to help you pay this off as quickly as possible and change your lifestyle to make sure it does not happen again.

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    the assumption of the United states is due to the mentioning of Roth 401K. – mhoran_psprep Dec 9 '15 at 11:34
  • Thanks! I just read up on the (roth) 401k details and we have similar saving/retirement plans here in The Netherlands. Enfin, knowing this will not change my answer. – Stephan Bijzitter Dec 9 '15 at 13:27

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