Tap My 401(k) or Borrow From Family?

A while back (actually, almost a year and a half ago now… how time flies…), I talked about using a 401(k) to pay off credit card debt. I largely viewed the decision as one that makes terrible sense on paper, but the decision can make sense in the broader terms of the choices life hands you.

This brings us to a question from reader “Mandy” who is going through a similar dilemma:

I recently ended a lengthy relationship with a person who used my credit recklessly. I am now left with about $30K in debt, almost all of it high interest. My personal credit is very poor, so I’ve been rejected for a personal loan from the credit union and have no way to consolidate that debt.

This leaves me with two options: tap into my 401(k) (which has a balance of about $40K) or borrow money from my family. I’m currently 34 years old and have a job that pays well enough that I can make the payments on the debt fairly easily, but building any sort of emergency fund is very slow and I’m unable to make much of an extra payment on the debt.

What are your thoughts?

If I were Mandy, my first plan of attack would be to call all my creditors directly. Call up every single lender and every single credit card company and play a little hardball with them. Request a rate reduction from each one. If you hear “no,” ask to speak to a supervisor. Tell them you’re going to have difficulty paying the bill. Ask if there are any balance transfer offers available to you.

In short, seek out everything you can do to get the debt itself into better shape. You’re likely to hear a lot of “no,” but even a few “yes” answers sprinkled in there will make all the calling worthwhile and take some of the heat off of your shoulders.

The next thing I’d do is look for sources of liquidation in my life. Do you have any items you could sell to help reduce some of that debt? Do you have a car in the driveway that you rarely drive? Do you have some old collectibles with significant resale value? If you can liquidate some things and use those to pay off the worst part of the debt, you’re likely in far better shape.

Once you’ve done these things – and assembled a debt repayment plan – and you’re still in a harrowing situation, then it’s time to consider the choice between borrowing from family and draining your 401(k). Neither choice, incidentally, is a good one.

A note: when I repaid my own debts, I did tap into a supplemental 401(k), though I left my primary 401(k) alone. My employer required all savings beyond the amount they would match to be placed into a distinct supplemental account, and I was contributing 2% beyond their match. It wasn’t much, but I did make the choice to tap it.

So, which is it: borrowing from family or tapping the 401(k)?

The first thing I’d do before making that choice is to carefully look at my debt repayment plan and figure out how much I actually need to borrow. Likely, you don’t need to borrow the whole $30K. Instead, you just need to eliminate some of the debt, getting rid of just a few of the monthly payments.

Once I had a grip on the amount that I needed to borrow, I’d collect all of the work I had put in thus far and talk to the person I wanted to borrow money from. Lay out everything – no hidden secrets. Let them know your exact situation from top to bottom.

Doing this will do two things. First, it will make that person into something of a mentor for you. That person knows your situation – they can become a helper (offering up good ideas) and a cheerleader (pushing you along to success). Second, it will make clear to the person you wish to borrow from the seriousness of the situation – and your seriousness in tackling it.

Having done all of this groundwork, and even given the general concern I have with lending money among friends and family, I would ask for a loan from a family member before tapping my 401(k).

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