Debt and a 401(k) loan
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August 9, 2000: 1:36 p.m. ET
Not sure how to erase all of your debt? Consider a second mortgage
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NEW YORK (CNNfn) - If you're saddled with credit card debt and you've already tapped into your 401(k) plan, you might not know the best approach to getting out of the red. What is the best way, and are there tax implications?
In response to a reader's question, Marc Collier, a certified financial planner from Wellesley, Mass., and a member of the Financial Planning Association, discussed the advantages of consolidating loans and outstanding debt with a second mortgage.
Ask the experts a question
I have credit card debt of approximately $7,000, and a loan against my 401(k) for another $18,000, with a remaining term of approximately nine years. I was considering taking out a second mortgage at 9.55 percent for four years to consolidate these debts. What do you think?
In general, it makes sense to consolidate the loans into the second mortgage for a few reasons. One is that interest rates on credit card debt is often extremely high and is not tax deductible. The rates on second mortgages are often more reasonable and the interest is generally deductible for seconds up to $100,000. The 9.55 percent rate seems a little high, but should be far below that of the credit cards, especially after tax.
The loan against the 401(k) is something I rarely, if ever, recommend, unless it is a last resort and an emergency.
Again, although you are paying your own plan back with interest, it is not deductible and you are missing out on any potential market gains that money could be earning. The only time it could work is if we were in a prolonged 'down' stock and bond market.
Once you secure a second mortgage, you should make a regular payment plan of both principal and interest, being sure to pay it down well before retirement.
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