Get Out of Debt Guy - Steve Rhode

Should I Borrow From my 401(k) or Home Equity to Eliminate My Debt?

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Question:

Dear Steve,

I have approximately $150K in credit card debt. I have a 401k worth about $500K with the ability to take out a loan of about $103K. I call it “credit card” debt, but it’s actually two Sofi loans totaling about $83K and the rest is credit card debt. That Sofi loan is at about 6.5% for 60 months. I own three properties: my principal residence which is about $300K in avail equity, a rental with about $140K in avail equity and a VRBO property with about $150K in avail equity. I was trying to avoid borrowing against any of the properties I’ve mentioned.

Here’s my question. I’m trying to identify the best way to consolidate all of my outstanding debts. Right now, I’m paying approximately $4-6K per month servicing these debts and not feeling like I’m making much headway.

Currently, my idea was to take a loan on my 401k for about $105K and then use a tax refund of $25K toward the rest and the rest of the debt, just pay off like I’ve been doing. But, are there other options I should be considering? Something I’m NOT thinking about? Is there a way to convert this personal debt into corporate debt in some way? I’m trying to avoid borrowing against any of the equity in my properties, but I”m not sure if the process I’ve outlined above is the best way to go. Any advice would be greatly welcomed!

Michael

Answer:

Dear Michael,

Personally, I’m not a big fan of the 401(k) loan if it can be avoided. The market has been going great so any loan you take out of your 401(k) might seem like cheap money but you also have to factor in the market appreciation you will lose when that money is withdrawn. A 5% interest rate loan that misses out of a 15% increase in the value of the investments of your 401(k) is really a 20% rate loan.

Your primary options for dealing with this debt are to pay it as agreed or default on the debt and settle it. Defaulting on the debt will result in a negative notation on your credit report for up to seven years, and possible legal threats or lawsuits to collect the debt.

The negative mark is not the worst case scenario and will become less of a factor as time passes.

I would guess your settlement cost would be around $75,000. However, the amount of debt forgiven by your lenders may be taxable up to the extent you become insolvent.

I can’t see any way to convert the debt into corporate debt. A fixed rate loan against a property would give you stability in knowing what the actual cost of the loan will be.

Your situation is a good example of how problems like these have two components; a math problem and goals/emotions.

I would suggest you meet with a local Certified Financial Planner if you just want math and technical advice. They can run the specific numbers for you based on your 401(k) investments, return projections, and the cost of pursuing a loan.

If you want to talk through your overall situation and work towards a goal that more closely meets your goals and wishes for the future, I would suggest you schedule a conversation with the debt coach friend Damon Day. His experience in working directly with people facing similar issues will give you invaluable feedback.


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