After some discussion on a related topic in behavioral finance last semester, I did something likewise unintuitive and took a massive loan out of my 401(k). The money all went directly into paying off credit cards and other debts, which had an average rate of perhaps 9%. The 401(k) loan has a rate of 4.25% so I’m still paying interest, but with three important differences.
First, the loan payments come directly out of my paychecks (fixed amounts and dates for a known period of time) so they can’t be missed or underpaid or anything else and personal financial planning is easy. Second, the 4.25% interest rate is much lower. Third and most important, the interest goes back into my 401(k). Meaning that I’m paying myself 4.25% instead of paying corporate usurers 9% plus whatever fees and other nonsense. (There was only a single $50 fee or something for taking the 401(k) loan).
In addition, the 401(k) loan does not show up on credit reports or anything, so now my already very good credit looks even better. And finally, if something happens with my job and the 401(k) loan “defaults”, then it is considered nothing more than an early withdrawal from retirement funds to be taxed normally plus the 10% penalty. No credit report effect.
That last bit is even more interesting and counter-intuitive. Straightforward math shows that it makes sense to get your 401(k) match and free money, then yank it all out and pay a 10% IRS penalty if you’re paying off those 24.99% credit cards.
The strategy really only works if you are disciplined to: 1) pay off much higher interest rate debt with the entire amount of the loan/early withdrawal, and 2) not start accruing new debt by using the CCs again. So if someone does this, get out the scissors afterwards.
This is not investment advice, you are not my client, I am not licensed, go see your financial advisor.
(I can’t wait to get a job somewhere else so I don’t have to be a disclaimer douche in every finance thread.)