Struggling homeowner reliant on credit looks at raiding 401(k)


Credit Smart
Credit Smart columnist Susan C. Keating
Susan C. Keating is the president and chief executive officer of the National Foundation for Credit Counseling. Prior to joining the NFCC, Keating spent 29 years in financial services. She was the highest ranking female CEO of a U.S. bank holding company, serving as president and chief executive of Allfirst Financial Inc., the largest U.S. holding of AIB Group. She currently serves on Bank of America's National Consumer Advisory Council and is a board member of the Council on Accreditation. Keating also participates in the Financial Regulation Reform Collaborative, a nonpartisan group committed to finding solutions for reforming financial services regulation.

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Question Dear Credit Smart,
I am a proud veteran and homeowner who purchased a new home back in 2004 when the market was great AND I DID NOT OVERBUY like most people did just before the balloon burst on the real-estate market in 2008. That was just the beginning of my financial troubles. Up until then everything was great. My mortgage was under control, gas prices were steady, the economy was in “good” shape. But all that changed in 2008. My home value depreciated by more than 45-50 percent, gas prices skyrocketed and, well, you know the rest.

I became more and more dependent on credit than I had in the past and now it has caught up to me. Recently, over the past few years my home value has increased some, but not to my liking obviously, and I was hit with a financial hardship in that my primary vehicle that I drove is now out of commission and in desperate need of a new transmission which is upward of $1,500.

My monthly total bills are now exactly even with my monthly income, and that is before taking on another car payment just so I can get to and from work. I have one credit card that is about to hit its max and I can’t get it extended any more. I have no wiggle room and with struggling for so long to keep up with a depreciating home due to careless use of other people’s money I am paying the consequences of other people’s poor judgment and bad decisions. I don’t qualify for a refi or HARP because my credit is good and I, No. 1, make too much, according to lenders or No. 2, I am not behind on any mortgage payments or No. 3, there isn’t enough equity in my home because of the valuation.

What can I do to reduce my credit card debt? I am at the point of taking money out of my 401(k) and saying screw it to the tax penalty. – Shane


Dear Shane,
I want to start out by thanking you for your service. I am so sorry to hear of your difficulties. Unfortunately, your story is not all that unusual but I know that is small comfort for you.

On an individual level, there is not much to be done about home value depreciation and rising costs. And I know that at the time, you did not feel like you had much choice but to use your credit cards. But, as you have found, credit is not unlimited and at some point you have to make a decision about what to do about your debt. It seems you are at that point now.

You mention taking money from your 401(k) to pay your debt, which is certainly an option you have. However, there are other consequences besides the tax penalty (which can be fairly substantial by itself). The money you have in your 401(k) is for your retirement and taking money out of the account not only reduces the amount you have already saved for retirement, it also reduces the earnings you gain from letting that money work for you. It is certainly an option, though. If you decide to do this, I would suggest you look into a 401(k) loan rather than a straight withdrawal if you can. This will eliminate the tax penalty because you will pay it back. Even though you will have to pay yourself back with interest, it will probably not make up entirely for what you lost. If you feel like you cannot afford to make payments to yourself, then a straight withdrawal may be the way to go.

Before you make the decision to do this, I would suggest another option. Contact a certified, nonprofit credit counselor to discuss your situation. You say you don’t qualify for a refinance of your mortgage and you truly may not. But many of these agencies offer housing counseling and may reveal options that you don’t know about. An effective counselor will look at your entire financial situation and help you select the options best suited to address your debt. Even if they cannot help with your housing, they may be able to help with your credit card debt through a debt management plan. This plan generally reduces the interest you are paying on your cards, as well as stopping late and over-limit fees if you are starting to get those. These plans are typically designed to get you out of debt in five years or less.

After reviewing your situation, the counselor may well advise you to look into the options available to you on your 401(k) if a DMP or home refinance will not work for you. They will probably also talk to you about your bankruptcy options, but from your letter, I don’t believe that is something you want. Still, it is good to know what your options are. Your credit counselor cannot give you legal advice, so if you do decide that bankruptcy is your best option, you will have to speak with an attorney.

My suggestion for the best place to find a counselor is through the National Foundation for Credit Counseling, but you also have other options for finding qualified counselors.

Remember to always use your credit smarts!

See related: Withdrawing versus borrowing from a 401(k)

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Published: July 23, 2016

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