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When I first spoke to you, I had just paid of my cc debts and was working 2 jobs and saving a little money. 4 years later, and I have since moved from NYC to Miami, got married, just had a baby, and right now I am in the process of buying our first home. (Not an investment, but our primary residence.)
With all of the life changes that have happened, my savings is gone (we had to pay for the move, marriage, and honeymoon ourselves) and over the past 2 years I have watched as my credit card debt has risen to over 13K. I have a very well-paying job, making 130K in Miami as a computer programmer, but right now I am the only source of income, as my wife is not working.
Anyway that is a quick catch-up with my life to date. And I have question for you.
Once I close on my house, my next move is to get rid of cc debt. Here are the 3 choices I see available to me. (Perhaps there are other ways, I am just not aware)
A. Pay it down heavily and hope to pay it off over 2 years.
B. Move it over to a 0% card for 15/18 months.
C. Take a loan out against my 401K to pay it off credit card immediately
Chris also wanted me to know that the “loan against my 401k is special in that the 4% interest I pay back is added back into my 401K account. So every penny I pay goes back to my pocket. There is no hit to my credit, since I am borrowing against my own funds, and it allows me to pay back less aggressively.”
What would you do? Please help me help Chris by choosing one option from the poll …
Note: if you chose ‘other’ please leave a comment; if you didn’t choose ‘other’, please still leave a comment 😉
Not only do you need to pay them off ASAP. You need to cut them up so you don’t rack up debt for a third time…No one should be putting a honeymoon (aka vacation) on a credit card without a clear plan to pay it off.
The using your 401k to pay off the credit card sounds on the surface like a good plan.
However, he needs to weigh against what he could earn(inside his 40k) against what Both,what he saves from paying off this debt,and what he puts back in .
If he is paying himself 4% interest into this 401k program,but could earn 7 % by not taking it out,seems like a bad idea.
How much is the current interest on the credit cards? Another question is,if he had already paid down these credit cards in the past,why is he using them again to rack up all this debt.
I see credit cards as a vehicle to be used only if your going to earn money by using the card.
Even then, if its not going to earn more than the interest your paying on the card, its foolish to get into this trap of using credit cards..
With the little we know about this situation, it appears as if he is making moves on a day to day basis,without a real plan. Could he have saved more for this move before making it to reduce his debt level??
Did he look at(and Plan for the real cost of this move?
Will this move reduce his cost of living,while at the same time increase his earnings?
“No one should be putting a vacation on a credit card without a clear plan to pay it off.”
@ Chris – Wise words!
@ Steve – Great questions … I wonder how our reader would answer them?
Thank you to everyone who took the time to vote and comment.
First let me address Chris:
At the time of the marriage/honeymoon I still had enough in my savings to just about cover it. Before committing to everything I had figured I would be about 2K in debt by the time it was all done. And I really didn’t think that 2K was bad at all. I see now that I did not allow for all those little expenses that seem to go with weddings. The 2K of debt I thought I would have turned out to be 5K.
And now Steve:
As of today my YTD ROR for the 401K is 5.3%.
The APR I pay to my credit card is 14.24%
My current card pays 1% cash back at the end of the year, which initially led me to put as many of our monthly bills on it as I could.
The question you ask about why I paid my debt to 0 before and now have it back up is the big question.
I had paid everything off by working a second job on a 6-month contract. It enabled me to pay off the credit card and save about 20K. To make a long story short, our engagement, moving states, new dog, marriage erased my savings and put the 5K dent into my cc. Still I thought I could manage that pretty quickly and get it back to 0. However with my wife’s pregnancy and then the birth of my son it all just spiraled way up. The hospital costs alone were 1,500 WITH my insurance plan. I figured I would buckle down after everything settled down and get us back on track.
Before I wrote to Adrian I had the very myopic view, that if I just keep my head down and throw as much money as I can at the credit card, it would take care of itself. If insanity is defined as doing the same thing over and over again expecting a different result, then I’ve been handling my finances like a madman 🙂
That is what led me to reaching out to Adrian. I thought that a 401K loan would allow me to cancel out the 14.24% interest I am paying on bad debt while freeing up some of the money I pay to the cc to increase my investing. I currently have about 7K in my trading account.
From what I see on the poll, it looks like the majority think transferring to a 0% card is the way to go. However I am curious as to what the commenters think?
@ Chris – thanks for sharing by e-mail and here. Re the 401k (and, it’s a close call IMHO), I agree with Steve when he says:
“If he is paying himself 4% interest into this 401k program,but could earn 7 % by not taking it out,seems like a bad idea.”
DISCLAIMER: We use ‘case studies’ like yours to stimulate discussion of general financial issues. Nobody really knows enough about your situation to make these comments relevant to you 🙂
Balance transfers are good because they allow you to extend the payback timeline on an interest free basis so that you can continue to enjoy your life without agonizing over debt. Some things are more important than money and I feel that marriage, honeymoon, and kids qualify.
In this interest rate environment, you can probably find a card that will give you 0% interest through 2014. If you’re diligent about paying off your cards, you should be able to make a significant dent in your debt over the next 1.5 years. Frankly, with the way the economy is going, I’m pretty sure that rates will still be low in 2014, so you could probably roll your credit card debt over again in 2014 through 2015 or 2016.
I don’t recommend borrowing against retirement money because in the event of another life event your retirement savings gets plundered – that’s not good.
@ Jackie – Probably some of the best specific advice that Chris could hope to receive IMHO (emphasis on ‘opinion’ because I’m guessing that neither of us is a qualified financial advisor).
Hi Jackie,
In the end, that is what I ended up doing. I already had a discover card with a 0 balance offering me an 18month 0% transfer that I took advantage of. And I like the idea of paying it back over a 3 year cycle. As long as it at 0% I have no real reason to rush to pay it off.
I still like the idea of a loan against the 401K, but now I am thinking of only doing that for an investment purpose (such as buying a rental property)
Thank you for taking the time to comment!
“I still like the idea of a loan against the 401K, but now I am thinking of only doing that for an investment purpose (such as buying a rental property)”
@ Chris – Sounds good to me! Just make your comparison (i.e. likely return if money left in 401k v likely return if withdrawn and invested) using after-tax dollars.
I think that if you’re somewhat cash constrained housing is generally a poor asset class. Housing’s like a leveraged buyout. You put in a little equity up front and fund the rest of the purchase with debt. The real value from housing comes when you sell the property or refinance because you’ve increased your proportion of equity ownership through mortgage payments and thus are entitled to a larger percentage of the transaction price than you put in upon initial purchase. For example, let’s say that you buy a house for $100K with 30% down. You’ve put in 30% of equity, with the remaining 70% coming from debt. You then sell it 4 years later for $150K. Your 4 years of mortgage payments have caused your equity ownership percentage to increase to 45%. That means your equity percentage of the purchase price is $67.5K. Compared to your initial $30K cash investment, you’ve made 125% on your down payment, or 22% per year.
Because the housing market can stay crappy much longer than you can stay liquid or solvent, your finances can be placed under significant pressure if (a) it takes longer than expected to find a suitable renter, (b) your rental revenue less management costs is less than your monthly mortgage, (c) the house needs significant unplanned repair, or (d) you’re underwater for a significant period of time. Of course, housing in certain cities (NYC, DC, Boston, and Chicago) is somewhat immune to the above due to consistent demand, but you’re also not getting a sweet deal on your housing purchase because of that demand.
There are a number of more liquid asset classes that can generate double digit yearly returns with less liquidity risk without the withdrawal penalty if you do your homework.
@ Jackie – Only residential real-estate; in most markets, commercial real-estate is valued on its current/future ability to create income.
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In today’s world, credit cards are the norm. Unfortunately, many people lose control and are unable to make their payments, ending up with a large amount of debt. If you find that you are in this situation, you probably feel as though you will never get them paid. The right way to pay credit card debt off is to make a list and prioritize each debt.