I've written before about using a home equity loan or line of credit (HELOC) to transfer debt away from credit cards.  Last month, I discovered another possibility for those with a 401k account at work.  Most 401k accounts let you take a loan against the funds, usually up to around 50% of the value in your account.  For me, there was also a $125 origination fee.  I have to say up front that experts I admire generally frown on this strategy.  There's a good discussion of this issue at Poorer Than You, and Liz Pulliam Weston over at MSN Money claims this is one of the 7 most common 401(k) blunders.  Here's what her article says:

What seems like a great idea - Borrow your own money! Pay yourself interest! - has plenty of traps for the unwary:

~ The biggest pitfall is the risk you take should you lose your job. Your loan would become due, and, if you couldn't pay it back at once, you would owe income taxes and penalties on the unpaid balance.

~ The interest rate you pay yourself may be lower than what you would pay most other creditors, but paying yourself interest is no substitute for the real return you would be earning if you had invested those payments instead.

~ Borrowing from your retirement funds is often a sign that you're overspending - particularly if you're using the proceeds to pay off credit card debt. People who use "easy outs" like 401(k) and home-equity loans to pay off their cards often don't change the underlying behavior that put them in the hole. They just run up their balances again, winding up another day older and deeper in debt.

I certainly agree that you better have a very stable job in order to pull this off.  Her second point about low interest you would pay yourself is a little confused.  Sure, if you put all your payments in higher yielding investments, you'd come out ahead.  But we're talking about debt consolidation here.  Those payments are going to credit card companies.  With this strategy, you pay yourself the interest instead of paying the card issuer.  The real issue here is that you have an opportunity cost - your 401k account should earn better returns over time than the interest you would pay into it on a 401k loan.

 The third point is very pertinent, and probably the biggest danger.  If you fall into the trap of paying off debt without changing spending habits, you'll likely end up with twice the debt - financial suicide!

However, for me, I believe I have a handle on my spending habits, and I've been pretty good about sticking to a debt reduction plan, having chipped away $25,000 in debt over the last year and a half.

 As I am still bitter over the crashing of my FICO score and subsequent dissintegration of my refinance (thanks, Bank of America, Equifax, and Experian, argh!), I discovered one very compelling reason to use a 401k loan to consolidate credit card debt - your FICO score improves significantly!  In my case, I moved $20k in debt from credit cards to a 401k loan. I believe this is the general case - that the 401k managers do NOT report to the credit agencies. So from the perspective of Equifax, Experian, and TransUnion, I just paid off $20k of credit card debt. The 401k loan does not show up as a new trade line, and no inquiry is reported, additional bonuses as far as the FICO score is concerned, relative to other loan consolidation options. The 401k loan is, of course, a loan obligation, so if you apply for a mortgage or other loan, it does need to be reported to the financial institution.

I probably sound overly enthusiastic, so I must say that I do see the consequences of what can go wrong. This is not for everybody, and options need to be carefully considered. I would only recommend it for those with a very stable job, ample funds in a 401k, and a comfort level with low interest-bearing 401k performance. It is particularly attractive if you need a FICO boost, as in the case of an upcoming large purchase or refinance.  For me, my FICO jumped approximately 40 points.  I have resurrected my refinance mortgage application, and it looks like I will be able to complete that over the next few weeks.  Of course, I had to report the $20k loan on my application, so I am waiting to see if there are repurcussions there.  I'll report back here if this becomes a major issue.

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