Tuesday, October 01, 2013

Taking out a loan from retirement to pay off credit debt

This week, I got a loan from my 457b plan to pay off my credit card debt. I know that this is a big no for a lot of people.

[[ Why I chose to use my retirement to pay off credit debt? ]]

1) I am facing quite a reduction in take home pay

2)the 457b plan currently has a 4.5% interest rate versus my credit card's interest rates, some of which runs close to 23% interest rate.

3)I am on a 5-year pay off plan and even if I pay the minimum payment each month, there's an end in sight versus the "21" years it would have taken me to pay off my credit cards if I just made the monthly minimum payments.

4) The monthly payment would be consolidated to $277.00 per month versus being close to $500.00 each month.

[[ The Catch? ]]

1) You can't pay more than the minimum each month. It's a set payment. This means that even if I can pay more than the minimum each month (not likely in the near future), I wouldn't be able to apply the extra amount. I would have to save the extra "payments" in the savings account until I can have enough to pay off the entire loan.

2) There is a $50.00 processing fee that the plan administrator takes out from the retirement account as well as $50 per year (for five years) for annual maintenance fee for the loan. That sucks too.

3) Third catch is that I'd be losing shares that were bought at lower share amounts to buy back shares that probably would be higher. AND I would be paying back the amount contributed with before-tax dollars with after-tax dollars.

There was an online calculator that I used through my retirement plan (not sure how accurate it is..) to calculate what my estimated loss through the plan versus if I had not taken the loan out.

Variables set were if I were to keep contributions the same as always, if I continue to contribute until 65, and if the market performs at 6% annual returns or more.

I would lose approximately $9,000 in market gains by the time of retirement with the loan taken out versus no loan. That is less than what I would pay in interest during the next five years, if I were to make minimal payments.

Maybe over the next five years, my share buy dates would be on down days and after the next five years, the economy does very well and the share prices rocket!

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