I am thinking of borrowing from my 401(k) to consolidate debt. Is that a good idea? -- Jane
Not generally. I know that there's a perception out there that borrowing from your 401(k) is good borrowing because, in essence, you pay interest back to yourself. That's true. However, borrowing from a 401(k) carries other risks: When you pull money out, you rob yourself of the chance to let that money grow for your retirement. So if the market suddenly goes crazy, you'll miss earning the greatest potential. Also, If you were to lose your job, your company could demand repayment of that loan in 60 days. If you were unable to repay the money, it would be taxed (as income) and penalized (as a withdrawal). That could easily cost you 30 to 40 percent of the amount you originally withdrew. Ouch!
Do you have other options for consolidating your debt? A home you could borrow against? While not as cheap as it was a few years ago, a home equity loan is still a decent option. Or maybe you're getting great credit card offers in the mail. Sometimes a series of balance transfers to cards with low (0 to 5 percent) interest rates for 6 to 12 months is the best way to go.
Whatever you decide, I want you to promise me that you'll take a good hard look at what created this problem to begin with -- and put a stop to it. One thing we know about people who consolidate debts is this: A few years down the road, about one-third of them have gotten themselves into even deeper trouble. You don't want to be part of that third. So get rid of this debt and strictly budget yourself so you'll only spend the money that you actually have.
>> More Money Q&A with Jean Chatzky
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Jean Chatzky is a money coach and the financial editor for the Today show. She is the the author of of five books including the upcoming Make Money Not Excuses: Wake Up, Take Charge, and Overcome Your Financial Fears Forever.
>> Buy it now
>> Check out her website, jeanchatzky.com
by The Nest Editors
7/1/08
See more:
getting out of debt,
Money