Is it a bad idea pay off credit card debt with my 401k?

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Is it a bad idea pay off credit card debt with my 401k?

William Mitchell
New to Real Estate · Gilbert Arizona · Member since 2021 · 31 posts · 18 votes

Hello All,

This is only my second post so I hope this is the correct  forum. 

We have over $20k in high interest credit card debt and the payments are keeping us cash strapped every month. We are just starting to look at real estate investing and feel that it will critical to pay that off as soon as possible. I have $30k in my 401k and was curious if there was a way to withdraw that to pay down the debt penalty free or with as little fees as possible.  I do not plan on investing any more into the 401k as we are going to be focusing on real estate investing.

We also have $250k in equity in our home but thought we would it might be better to use that for our first investment property.

Obviously we are just starting out in this and not even sure what questions to be asking yet. I appreciate any and all feedback. 

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Cory LucasPro Member
Rental Property Investor · Brighton, IL · Member since 2019 · 431 posts · 139 votes
5y

I don't think I'd use my 401k for that, but you know your situation better than I

Personally I love my 401k and utilizing it for investment purposes, there's a lot of reasons to do so. Some of those highlights are 1. It's tax deferred money, so I dump as much as I can in there and it doesn't get taxed, win win! 

2. When you take out a loan on it that doesn't show up on your credit report, win again! 

3. Interest is usually pretty low, 4.75%, but the big kicker is when you pay it back you get the interest! Not a bank

So for me I'd keep dumping money into it and as for the credit card debt I can understand that it's likely crushing you as far as payments, but have you heard of the Debt Snowball as illustrated by Dave Ramsey? That's where I'd start on getting that paid down, but keep your built up capital (i.e. 401k and Equity in your house) for investment purposes

Hope that helps and happy to elaborate further or clear anything up if you need :) Happy investing 

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  • Cory LucasPro Member
    Rental Property Investor · Brighton, IL · Member since 2019 · 431 posts · 139 votes
    5y

    I don't think I'd use my 401k for that, but you know your situation better than I

    Personally I love my 401k and utilizing it for investment purposes, there's a lot of reasons to do so. Some of those highlights are 1. It's tax deferred money, so I dump as much as I can in there and it doesn't get taxed, win win! 

    2. When you take out a loan on it that doesn't show up on your credit report, win again! 

    3. Interest is usually pretty low, 4.75%, but the big kicker is when you pay it back you get the interest! Not a bank

    So for me I'd keep dumping money into it and as for the credit card debt I can understand that it's likely crushing you as far as payments, but have you heard of the Debt Snowball as illustrated by Dave Ramsey? That's where I'd start on getting that paid down, but keep your built up capital (i.e. 401k and Equity in your house) for investment purposes

    Hope that helps and happy to elaborate further or clear anything up if you need :) Happy investing 

    10Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    @William Mitchell

    Yes, this is bad idea!

    Early distribution from 401k will result in penalties on top of ordinary income tax so this would be unwise. If you are serious about paying off your debts - you can do it. Here are just a few ideas: if you have newer car that is financed sell it and get older reliable used car such as Honda or Toyota. Cancel any subscriptions you may have (gym, cable, etc), stop eating out, get a second job or start a side business. Be sure you have emergency fund and start saving $$$. Live on budget. Get your financial house in order (or at least be in control of it) before you jump into real estate investing. 

    If your employer offers company match in 401k be sure to contribute up to the match, that is free money and it would be foolish to give that up. Also retirement funds can be invest in real estate via self-directed IRA. 

    8Reply
  • Seidy Lasker
    Realtor · Phoenix, AZ · Member since 2020 · 79 posts · 37 votes
    5y

    @William Mitchell

    Cash out refinance and pay it off with the equity in your house and use the rest to invest. You’re not going to beat 2-3% interest rates.

    Don’t buy bad investment properties or else you will be in a big hole from cashing out the equity unless you have a job for security.

    4Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    5y

    You can get a HELOC and pay off the debt...or, as a second option that is less attractive, get a 401K loan and pay it off.

    5Reply
  • Justin Phillips
    Lender · Phoenix, AZ · Member since 2018 · 440 posts · 256 votes
    5y

    @William Mitchell If credit score and DTI are in-line, I'd definitely recommend looking into a Heloc.
    To take it a step further, a specialized 1st position Heloc tied to a zero balance sweep checking account works like the Dave Ramsey "debt snowball" on steroids. With it, all of your debt is combined in one place, with all of your income going directly towards paying it down. If qualification is there, there isn't a better way to pay down debt! 

    3Reply
  • William Mitchell
    OP
    New to Real Estate · Gilbert Arizona · Member since 2021 · 31 posts · 18 votes
    5y

    @Account Closed

    Thank you for your thorough response! 

    I didn't consider using my 401k loan for investments purposes. I am still very early in this journey so I thought only really thought of my house equity as the best way to do that. The more I am listening to the BP podcasts and looking through this forum I see there so many different approaches to this I just need to find what is right for me and not lock into one in particular.   Taking a loan against it is very interesting to me and sounds like a good option to look into!

    I have recently heard of the debt snowball and it does make a lot of sense. Need to buckle down and get some discipline! 

    Thanks again for your help!

    1Reply
  • William Mitchell
    OP
    New to Real Estate · Gilbert Arizona · Member since 2021 · 31 posts · 18 votes
    5y

    @Dmitriy Fomichenko

    Thank you so much for your candid response. Yes - Discipline could be a lot better and the first part of fixing it is admitting it - right? haha.

    Your article on the self directed IRA is excellent. Thank you so much for sharing. Tons of good info in there that I will have to read a few times to really wrap my head around.

    Thanks again!

    1Reply
  • William Mitchell
    OP
    New to Real Estate · Gilbert Arizona · Member since 2021 · 31 posts · 18 votes
    5y

    @Seidy Lasker

    Thank you for taking the time to respond and for the advice.  Trying to soak up as much as I can here on BP so that I make less mistakes! 

    0Reply
  • William Mitchell
    OP
    New to Real Estate · Gilbert Arizona · Member since 2021 · 31 posts · 18 votes
    5y

    @Mike Dymski

    Thank you for the feedback Mike! 

    0Reply
  • William Mitchell
    OP
    New to Real Estate · Gilbert Arizona · Member since 2021 · 31 posts · 18 votes
    5y

    @Justin Phillips

    Thank you for the response Justin! Our credit scores are good 720+ but I am not sure where my DTI stands. Is it just total debt divided by income? What would be considered good?

    I have never heard of a sweeping checking account but will be looking into that further for sure. What do you mean by "if qualification is there?"

    Continue to learn everyday. I am grateful for your help.

    0Reply
  • Justin Phillips
    Lender · Phoenix, AZ · Member since 2018 · 440 posts · 256 votes
    5y

    @William Mitchell DTI is your monthly debt payments divided by your gross monthly income. Ex. $1000 income, $480 payments = DTI of 48%. Most lenders like to see around 40%, but it can go higher in some situations.

    A ZBA, or Zero Balance Sweep account is simply an account that moves (Sweeps) money elsewhere every night. So in this instance, the account sweeps money from that checking account, and has it sit on your outstanding debt balance. This allows your deposits to work for you, rather than the bank. Your deposits save you daily interest by lowering your outstanding balance, and just sweep back off when it's time for the bills to be paid. It's the same way large corporations pay down their debt, on a much smaller scale.  

    This loan is an incredible tool, but not a very easy loan to qualify for, which is what I meant on the qualification piece. 

    2Reply
  • Joe Zinger
    Cary, NC · Member since 2017 · 46 posts · 14 votes
    5y

    @Cory Lucas 401k loan is a solid option but if I remember correctly leaving your employer can make you immediately pay the loan back in full.

    1Reply
  • Peter MckernanBusiness Member
    Residential Real Estate Agent · Irvine, CA · Member since 2013 · 2k+ posts · 1k+ votes
    5y

    @William Mitchell I would not pay off the credit card debt with the 401K due to the fee and the taxes you will incur on the 401K month. Unless you are 59.5 you should keep it in there, you can do a loan on the month for the 401K for up to 50K, but I would still explore other options prior to doing that route. I would suggest working overtime to pay it off, use your spare time off of work to start a side hustle, sell stuff on Offer Up or Letgo, or work with your spouse on creating something else as a secondary means of income to pay it off. That would be the best option. 

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    2Reply
  • Jonathan R McLaughlin
    Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes
    5y

    @William Mitchell of the options you list using the home equity to pay off the higher interest credit card debt seems like an absolute no brainer no prepay penalty and you trade high interest credit card debt for historically low, long term fixed rate debt.

    The 401k can be used to show the 3-6 month reserves that many lending institutions require when u purchase rental properties

    0Reply
  • Ian WalshBusiness Member
    Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
    5y

    It depends on your end goals but I assume the interest is in the double digits?  If it were me, and I didn't have a vehicle to easily offset that with the money I had, I would pay it off.

    0Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    5y

    @William Mitchell first of all, $20K in credit card debt is extremely high and abnormal. Unless you have cash to pay that off, it signals a self control problem. I wouldn't use your 401K or a HELOC to pay off that credit card debt. You need to pay it off the old fashion way, which is reducing spending and temporarily sacrifice lifestyle. That means no eating out at restaurants, no name brand clothing, no vacations, no expensive concerts or events, etc. If you don't actually sacrifice to pay off the debt, you will just run the debt back up again and be penniless in retirement. Sacrifice is hard work, but it teaches you self control and will prevent you from overspending again in the future. You shouldn't even be looking at real estate investing until you have your spending under control. Cut up the credit cards. Use debit cards and cash to buy things.

    6Reply
  • Craig Janet
    Member since 2019 · 223 posts · 261 votes
    5y

    First of all, you need to pay off the credit cards anyway possible before you invest in real estate. You are probably paying 10-20% interest. That's a pretty difficult return with any investment. I don't like 401K loans because you can no longer "contribute" and take advantage of the employer match (at least with my company).

    0Reply
  • Jaron WallingPro Member
    Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
    5y

    @William Mitchell Get on the phone and start ringing those local lenders! The smaller banks will work with you. I agree with everyone else to get a HELOC. That credit card payment is crushing you. I leveraged two cards to flip my primary but I'm paying them off with a cash-out refinance this week. Interest rates are low. I hope you can take advantage of that. Good luck man.

    0Reply
  • Theresa HarrisPro Member
    Member since 2019 · 15k+ posts · 11k+ votes
    5y

    If you have $20K in credit card debt and are having problems with payments, do NOT buy a property right now.  Sit down and look at your finances and find out how that $20K credit card debt happened.  Was it a one time thing where someone got sick resulting in extra bills and time off work or is it ongoing spending?

    Once you figure out what cause the $20K if it was ongoing spending, then adjust your spending.

    I would NOT take money out of your retirement to pay down that debt.  Do you have access to a line of credit at a lower interest rate that you could use?  Then pay it off before you invest in real estate.  Use the rental as your carrot to pay down that debt faster.  Start by paying down the one with the highest interest rate first.

    1Reply
  • Cory LucasPro Member
    Rental Property Investor · Brighton, IL · Member since 2019 · 431 posts · 139 votes
    5y

    @Joe Zinger you are 100% correct

    0Reply
  • Carlos Gonzalez
    Investor · Phoenix, AZ · Member since 2015 · 346 posts · 170 votes
    5y

    @William Mitchell

    You can use 401k to pay loans or credit cards with high interest rates. I would do that.

    0Reply
  • Jaquetta T Ragland
    Real Estate Agent · Winston Salem, NC · Member since 2014 · 486 posts · 303 votes
    5y

    @William Mitchell I too hate having consumer debt so I would probably look into the 401k loan unless there was another plan you could come up with. One that comes to mind is transferring it to a no interest / no fee credit card and paying as much as possible on it to pay it off without touching your 401k. The no interest period is usually 12-18 months so that time crunch makes you hustle and pay it off. While you guys are starting your investing career, you could also look for ways to make money on the side to pay it off. Maybe do some flips and with the profits, you could pay it off.

    0Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    5y

    Moving the pea under a different shell doesn't change behavior. 

    Moving the credit card debt from an unsecured revolving line to your house or borrowing or taking from your 401 is just masking the symptom.  

    Change spending habits by lining your debts up smallest to largest and punching them in the face.  

    Build your investing foundation this way. Wanting to get started with REI isn't a good reason to skip changing behaviors and mindset.

    4Reply
  • Alonso Escalante
    Lender · Irvine, CA · Member since 2019 · 13 posts · 5 votes
    5y

    @William Mitchell Based on what you mentioned, I'd keep the 401k as is. Do a cash out refi to pay off the debt and use the rest to invest. Note that you'll want to take a look at your DTI aka take a look at your credit report.

    Add up the payments on the outstanding debts, let's call that number X

    Take a look at your gross income, call that Y

    DTI = X/Y

    If it's less than 50% then you're good to go for the refi!

    0Reply
  • Matt BerresPro Member
    Laurel, MD · Member since 2019 · 3 posts · 1 vote
    5y

    @William Mitchell my input/question is your 401k generating a higher APR than you are paying for your CC debt? If no, AND you don't have a penalty for drawing funds out of your 401k for this purpose, then paying off that CC debt probably makes sense. But you also should view this as a one time fix and have a plan for repaying your "loan" from the 401k. I would assume you are looking at 12-19% APR on your CC so you are in the pocket of the CC company. Not a place you want to be.

    0Reply
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