Struggling With Credit Card Debt? Avoid These Big Payoff Don’ts
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By Kayla Sloan for MoneyPeach.com

If you have credit card debt, getting it paid off should always be one of your first financial priorities (besides paying for basic living expenses). In fact, getting my credit cards paid off once and for all is my biggest goal for 2016.

But as much as I want to do that ASAP, there are some things I will never do to pay off my debt, and you shouldn’t either.

1. Don’t Take Money From Your 401(k)

It may not be a bad idea to take some money from your savings account and put it toward credit card debt, provided you have enough left over to cover an emergency (and therefore avoid racking up even more debt). This is because it doesn’t make sense to be paying 10 or 15 percent interest—or more—on credit card debt while you have money sitting in a savings account earning almost no interest.

However, one thing you should not do is take money out of your 401(k) to pay off your credit card debt. One problem with taking a 401(k) loan is that the money you invested was contributed pretax. But when you repay the loan, you’re using after-tax money. Then when you withdraw money from your 401(k) during retirement, your money will be taxed again. Basically, you will be paying tax twice on the same money. (Plus, you’ll be missing out on potential gains while the money’s withdrawn.)

The other issue with taking a 401(k) loan to pay off credit card debt is that if you change jobs or get laid off before you’ve repaid your 401(k) loan, you will be required to pay it back very quickly—typically within 60 days. If you don’t have the funds to do this, you will then be taxed as if you took an early withdrawal from your retirement account. You will pay the ordinary income tax on those dollars, plus a 10-percent penalty.

2. Don’t Use a Home Equity Line of Credit

One difference between credit card debt and a mortgage is that a mortgage is secured debt and credit card debt is unsecured. This means that if you don’t pay your mortgage, your home could be repossessed by your lender and sold in a foreclosure in order to recoup as much money as possible. But if you don’t pay your credit card debt, the credit card company cannot force you to sell your home (or any other asset) to pay the bill.

When you take out a home equity line of credit (HELOC), you are taking out more debt against the value of your home. HELOCs generally offer lower interest rates than credit cards, and interest paid may be tax-deductible. These two “benefits” may make a HELOC seem like a good way to pay off credit card debt, but you’re transferring unsecured debt into secured debt. If you default on your HELOC, it’s possible the bank could foreclose on your home.

3. Don’t File for Bankruptcy

Filing for bankruptcy may appear like an easy way to have your debts forgiven, but it’s not a decision to be made lightly. For some, filing a personal bankruptcy could be a bigger financial mistake than getting into debt in the first place because the effects will stay with you for years to come.

A bankruptcy filing will damage your credit score and remain on your credit report for seven to 10 years. If you plan to purchase a new home or buy a new car during that time period, it will be difficult. If you are approved for a loan at all, the interest rate will likely be substantially higher for you than for someone who doesn’t have a bankruptcy on their credit report. What’s more, the cost of extra interest could potentially end up being more than you would have spent to pay off your debt in the first place.

Bottom line: There are much better ways to pay off your debt than filing for bankruptcy, or using the other methods above, like working with consolidation agencies and debt counselors (such as those recommended by the nonprofit National Foundation for Credit Counseling). They can help you dig out of debt by negotiating with credit card companies on your behalf.

Of course, using debt payoff methods, like the debt snowball or debt avalanche, are also extremely useful, and can help you get out of debt much sooner than you might think.

A version of this post originally appeared on Money Peach.

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2 comments

    Someone who doesnt have experience with 401k withdrawls or loans would be very confused by that portion of this article. There is little clarification that when you say “take money out of a 401k” you are talking about a 401k loan, not a withdrawl. Only at the end do you distinguish between an actual withdrawl and a loan.
    Inaccurate about taxes. If you take a 50k 401k loan, you get 50k cash (minus maybe a small processing fee of $50 or so). You pay back 50k cash + a small amount of interest that goes into your account. You are not taxed when you take out a loan, only when you withdrawl. Therefore you are not taxed twice.

    Joe, you are right that the loan did not get taxed when you take it out. However, when you pay back the loan you use after tax money (not before tax money as you originally contributed), then when you take it out at retirement the portion that you took out as a loan get taxed again. So to conclude, the total loan you take out will be taxed twice not the whole portfolio.

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