Borrowing From 401K For Credit Card Debt – Good or Bad?
Many plans allow borrowing from 401k accounts, and this loan is paid back with interest. For some individuals the temptation to take advantage of this to pay off mounting credit card debts can be high, and this may be a good or bad thing depending on the specific situation and circumstances. Unlike a 401k hardship withdrawal, which does not have to be paid back and involves a steep penalty, a loan from your account must be paid back. The upside of borrowing from 401k plans is that the interest you pay on this loan goes back into your account.
A 401k catch up contribution can be allowed in many situations, so that you can get your account up to the allowable amount. If you have credit card debt that is high, and you are paying outrageous interest rates on this debt, borrowing from 401k accounts may make good financial sense. A loan against your 401k does not have to comply with 401k withdrawal rules involving a hardship, and you will be paying yourself interest, have lower monthly payments, and improve your credit score. This should only be considered if the interest charged by the 401k plan is less than the credit card interest you currently pay.
If you are borrowing from 401k accounts to pay off high interest credit card debt it is important that you do not fall back into your old spending habits and run the debt back up after it is paid off. Most types of 401k plans allow for a loan against the account balance, including a number of safe harbor 401k plans. If you can not be disciplined and avoid putting additional charges on the cards once they are paid then borrowing from 401k accounts to pay off this debt would be a mistake. You could end up with the same amount of credit card balances as before, and two payments to make each month instead of one.