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-- Posted: Jan. 6, 2000

Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

Should I borrow from my 401(k) to pay off debts?

Dear Dollar Diva,
I have accumulated $53,000 in debt, including a $12,000 401(k) loan. I am considering taking out a second 401(k) loan for $22,000 and then negotiating with my creditors/collection agencies for a settlement amount. Does this make sense?

Also, some of this debt has already been charged-off. Do I ignore the charge-offs until I'm in a better position to pay them off?

Steps I have taken thus far to help myself:

  • I can't take on a second job. I'm a single parent and travel a lot with my job.
  • I don't have car payments (company car).
  • I am considering moving to an area where rents are about $500 less than what I pay.
  • I am pretty frugal, not buying anything for myself, no cable TV.
  • I am still contributing to my 401(k), but just the minimum (1 percent).

Without knowing how much you earn, the Diva can only give you some general guidelines to help get you out from under this debt.

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Should I borrow from my 401(k) plan to pay off debts?

It is generally not a good idea to borrow from a 401(k) plan to pay down debt, especially unsecured debt, like credit cards. If you leave your company, you will have to pay back any 401(k) loans. If you don't have the money, the IRS will treat the loans as distributions. You will have to pay taxes and penalties for early distribution if you are under age 59 1/2 when your employment terminates.

Negotiating with creditors

You don't have a car or house loan, so the Diva is going to assume the debt is all unsecured.

You need to make a list of your monthly expenses. Include an amount for savings, so you will not find yourself having to use a credit card for the next financial crisis that comes up. Subtract this amount from your monthly income, and that is what you have to pay your creditors.

Spending more money than you have is not a crime, so you don't have to feel guilty about approaching a creditor to negotiate a payment plan. You only have a certain amount of money to pay off your debts, and you want to work out payment plans that will be fair to all of your creditors. The best way is to meet with a representative of each creditor, show him your financial situation, and tell him how much you can afford to give him each month to pay off the debt.

If you can't do this yourself, go to a nonprofit counselor for help. Visit The National Foundation For Consumer Credit Web site to find a counselor near you. Most of the agencies are called Consumer Credit Counseling Service, and all will help you set up an expense plan and work with the credit card companies on your behalf. These agencies are funded by the credit card companies. Their goal is to keep you out of bankruptcy.

If, however, your debt is so large compared to your income that bankruptcy is the only way for you to get relief, then that's what you should do. Use a bankruptcy attorney if you decide to take this route.

Do I ignore the charge-offs?

You still owe the money even though the companies stopped trying to collect. Here are a couple of things to remember: The meter may still be running on the interest and finance charges. The longer they remain unpaid, the higher the balances become. If they check your credit report and see that you're paying off your other creditors, they may come knocking at your door for their share.

If they are not actively hounding you, you can make them a lower priority. Add them to the list of debts that need to be repaid, and consider them in your repayment schedule.

Current 401(k) contributions

The Diva usually recommends making the highest 401(k) contribution you can. You've had a problem trying to live on a regular paycheck. Think how hard it's going to be when there's no regular paycheck coming in.

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