Paying off your financial troubles is an admirable goal and a great move for your financial health. But some methods for doing it?might?hurt more than they help. Withdrawing out of your 401(k), draining your emergency fund or ignoring your regular bills in the name of coughing up off your credit debt may seem like good ideas within the moment, but they can have adverse consequences in the long run.
Dipping to your 401(k)
There are lots of reasons not to make use of your 401(k) to repay debt, but let’s begin with?the possibility financial ramifications. For money out?early – that is,?before age 59? – not simply will that money be taxed at the current income tax rate, but you’ll also pay a 10% penalty.
If your 401(k) has a loan provision, it?is really a more affordable way of paying off your financial troubles. However, 401(k) loans also provide?downsides. For one thing, anything you borrow won’t be earning a return before you pay it back. Should you quit or lose your job before repaying the borrowed funds, the entire balance?can come due soon after. And if you can’t repay it in full, it will likely be treated as a distribution – meaning you’ll incur the taxes and penalties of the early withdrawal. It is a risky move.
Finally, by using your retirement funds to pay off your credit card debt, you’re potentially setting a dangerous precedent. You’re making making use of your retirement fund an option for sticky economic situations, that could assist you to justify withdrawals in the future, even when they aren’t essential. Unless you’ve exhausted other legal options, try to leave your retirement savings alone for Future You.
? MORE: How to pay off debt
Draining your emergency fund
Because of high rates of interest on charge cards and low interest on savings accounts, it isn’t a good idea to keep a large cash reserve while carrying credit card debt from month to month. However, it is also not recommended to drain your money reserves completely to eliminate your financial troubles. Emergencies happen, and also you need to have some savings in place to deal with them because?credit cards isn’t an urgent situation fund.
The quantity of emergency savings you need to keep depends upon your individual situation. Like a starting point, everyone should have $1,000. Many people – like small businesses, custodial parents or sole breadwinners – may require more, while just one young professional with no mortgage will likely be fine having a small fund. Any savings greater than the thing you need for emergencies can be put toward debt, try not to drain your?entire rainy-day fund.
Neglecting your present?bills
When you’re anxious to get rid of your financial troubles permanently, it might be tempting to chop corners elsewhere to pay for it off as quickly as possible. But ignoring your payment per month obligations to pay for down debt is not a sound approach. You’ll likely get hit with fees, as well as your late payments might be reported to the credit agencies and grow in your credit reports for seven years.
Instead, pay your bills and minimum debt payments first. Then, provided you have a small emergency fund already, place the excess toward extra debt payments.
The bottom line
Pay down your credit debt aggressively, try not to hurt yourself financially by withdrawing from your 401(k), draining your emergency fund or ignoring your monthly bills. Instead, aim to reduce your financial troubles by making more or spending less, and allocating the?extra funds for your credit card debt.