If you’re saddled with a lot of high-interest credit-card debt, you might be tempted to pay it off quickly by borrowing from your 401(k) or taking out a home equity loan. Not so fast…
Borrowing from your 401(k) “should really be considered a last ditch effort,” says Colorado Springs, Colo. financial planner Linda Leitz. That’s because you lose out on two of the biggest advantages to workplace retirement plans: tax-deferred growth of your money and tax-deductible contributions. Also, you must pay your 401(k) back with interest, and that interest is paid with after-tax dollars. Plus, putting your extra cash towards repaying the loan will make it tougher to budget for additional contributions.
Also, if you quit or lose your job, you’ll probably have to repay the entire borrowed amount within three months. If you aren’t able to do that, you’ll owe income taxes on the money, plus a 10% penalty if you’re under 59-1/2.
As for home equity loans, these do typically have interest rates that are less than half what most credit cards charge. Plus, the interest you pay may be deductible (note that when you use a home equity loan for non-housing expenses, you may only deduct the interest paid on the first $100,000 of the loan). The catch: if you default on your home equity loan payments, you may lose your home. Moreover, if you start racking up credit card debt again, you’ll go into even deeper hock.
Better to transfer the balance to a lower rate card and start dumping money toward your debt to get it paid off.