While tapping your 401(k) for a loan to pay off credit card debt is an option available to many, it's important to understand the trade-offs, since there are implications for your nest egg and taxes.
With this in mind, The Motley Fool analysts Michael Douglass and Nathan Hamilton answer a user-submitted question in the video below about whether it's smart to take a 401(k) loan to pay off high-cost credit card debt. Tune in to learn more, and why Fools suggest balance-transfer credit cards as a strategy worth considering. If that sounds like a fit for you, then reviewing The Motley Fool's picks of the best balance-transfer credit cards is a good first step.
Michael Douglass: Tracy asks, is it wise to take a 401(k) loan to alleviate high interest and improve credit score?
Nathan Hamilton: You're the 401(k) guy, Michael.
Douglass: Tracy, we can't speak to your specific circumstances. Generally, speaking, I tend to think, if you're looking to alleviate high interest, the best way to do that, in my personal opinion, is with no interest. That is a balance transfer card. 401(k) loans are fraught with a lot of other issues that we can get into in more depth some other time. But, my general sense is, if you have high interest, a balance transfer card is often the best move there, because you can take that high interest rolled over to no interest, and have 8-15 months to pay it off at no interest. If you can then snowball those payments and get it all paid off during that time, that's really the dream.
Hamilton: Yeah. It always makes me uneasy when I hear about people tapping into their 401(k), or looking at their IRA, taking funds out to cover near-term expenses. But balance transfer credit cards, absolutely yes. Also, there are other options out there, be it personal loans, where the rates can be better than what you get with a credit card. Even if you have excellent credit and a really competitive credit card, you're still likely looking at, in the best-case scenario, a high single-digit interest rate, and that's rare.
Douglass: Usually it's mid to high double digits.
Hamilton: Yeah, you're looking mid-to-high teens for most cards. Perhaps a low APR card, you can get more competitive. But, there are more personal loans out there, there are a ton of them, be it on the internet, local credit union, banks, anyone like that, where you can get a more competitive rate, and it might make sense to take out a personal loan to pay off that credit card debt instead of using your 401(k), because when you're using your 401(k), you're taking money out of the market and losing that potential gain in the future in favor of paying off a debt. So, with a personal loan, you can get the best of both worlds, you can pay off your higher interest debt with some lower cost debt but also keep your money invested.
Douglass: Yeah. And when tapping into retirement accounts, there are tax implications, which, depending on the retirement account and your circumstances and all that, can be substantial. My general sense is, when I'm budgeting and when I'm thinking about expenses and all kinds of stuff, I treat the retirement accounts like they're not under my control, so I just stay away from them completely, and basically only in the event of really, truly bad circumstances -- I'm talking near bankruptcy -- would I personally start tapping into my retirement account. That's my two cents.