Living within your means

Using retirement to pay off high debt isn't the answer

By Todd Ossenfort

The Credit Guy

The Credit Guy, Todd Ossenfort, is a credit expert and answers readers' questions about credit, counseling and debt issues. Ask a question 'The Credit Guy' archives

Dear Credit Guy,
I have over $30,000 in credit card debt and also have a high mortgage payment. I would like to know if I should borrow money against my 401(k) to pay off the credit card debt or if there is any type of negotiation I can work out with the credit card companies. I have heard of people not paying their credit cards altogether and waiting for it to go to a collection agency. The collection agency will then work out a deal. Can't credit card companies do the same thing? -- Anita

Dear Anita,
Wow! I hope your job is secure. You definitely don't want any decrease in your monthly income with a high mortgage payment and that large credit card debt load!  Judging from your question, I am willing to bet that you don't have a budget, and you are living beyond your means. Things need to change.

Borrowing money to get out of debt is something I highly advise against. However, I know money sitting in a retirement account is very tempting in situations such as yours -- particularly when you have probably taken a pretty severe hit recently on your balance, as have most people with money in the stock market. Now is not the time to bail out.

Here are just a few reasons NOT to borrow against your 401(k) account:

• It is virtually impossible to make up the interest gains you would make if you left the money alone. Yes, even with the severe dip in stock values at the moment, if you leave that money alone it will eventually begin to grow again. It can only do that if it is in the account and not being used to pay down your debt.
• You will pay taxes and penalties on the unpaid balance if you default on the loan. 
• Generally, you can only borrow $50,000 or half of your vested balance, whichever is less.
• You must typically repay the loan in full within five years.
• You might not even qualify to do it. Read your 401(k) plan summary to determine if you currently qualify for a loan. Some employers only allow loans for financial hardship, such as avoiding foreclosure on a primary home, purchasing a primary home or paying medical expenses for yourself or a spouse.

Your idea of negotiating with your creditors is much better than borrowing from your 401(k) account. The very first thing I recommend you do is sit down and establish a realistic monthly budget with a plan for how to attack those credit card balances. To do this, you may need to seek professional help from a qualified credit counseling agency, but you should only work with an agency that will offer a free, initial meeting with you to determine your best course of action. You can find a qualified agency by visiting www.aiccca.org or www.nfcc.org or by calling (866)703-8787.

Obviously, waiting until your account is charged off by the original creditor and then purchased by a collection agency is going to do significant damage to your credit history and score. It's something you should avoid. It would be much wiser to negotiate now, before you are late on payments, rather than wait and then deal with a collector.

If you would like to take a shot at negotiating with your creditors yourself, be prepared to present the reasons why you should be given a reduced interest rate or whatever other concessions you'd like to receive. Those reasons could include your excellent credit score, your good payment history, offers from competitors (with the terms you are seeking), etc. You may need to request to speak with a supervisor to see any real action taken on your account.

Many creditors offer hardship programs for those customers who can provide proof and qualify for the program. Examples of reasons you may qualify for a hardship program can include: any changes in employment, such as losing a job or simply working fewer hours; or a family situation change, such as a divorce or a medical emergency involving a direct family member. Be aware that the creditor may close your accounts if you are given any type of concessions.

Unfortunately, during the current credit crunch, you may find it more difficult to negotiate your debt on your own.

Remember, take care of your credit!

See related: 6 credit card terms you can negotiate and change, Beware of tax bite that may follow debt resolution, Deep in debt? You may be able to cut a better settlement deal

Todd Ossenfort is the chief operating officer for Pioneer Credit Counseling in Rapid City, S.D. Pioneer Credit Counseling has been a member of the Association of Independent Consumer Credit Counseling Agencies since 1997.

The Credit Guy answers a question about a debt or credit issue from a CreditCards.com reader each week. Send your question to The Credit Guy.

Published: October 27, 2008

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