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How to Decide on Taking Out a Payday Loan or Borrowing Money from Your 401(k)

By Lyle Solomon May 07, 2024 Managing Money

Dealing with a financial mess can be difficult. But borrowing money from the wrong source can exacerbate the situation. When it comes to your 401(k) savings, your goal should be to let that money grow to have funds for retirement.

This money should not be included in your emergency fund. But is a payday loan a better option?

How Are Payday Loans Helpful to Retired People?

These loans are the instant answer to emergency cash needs. There might be such situations, especially in retirement, where you need cash for an accident or repair services at home and in critical circumstances.

As you live within a certain amount during retirement, paying for such needs becomes challenging. Thus, payday loans come as a savior for you.

You can find plenty of payday loan websites on the internet. And they are simple. You have to fill out the forms available on the corresponding website and submit them online. You will find the amount you have applied for credited to your account within 12 to 24 hours. The reason for such fast processing is that no documents or credit score are checked.

How Do Payday Loans Help People Who Are Nearing Retirement?

There are many reasons why payday loans are popular. First of all, they address an immediate cash need. There is no alternative to payday loans when you need cash very fast.

Secondly, people nearing retirement don’t want to take out loans against their retirement savings accounts. To meet immediate cash needs, they rely on tools like the payday loan. However, they need to make sure to repay the loan on time. Otherwise, falling into debt just before retirement can bring dire financial consequences.

The third – and perhaps the most admired – fact about payday loans is that they don’t require any credit check. Thus, even if you have tarnished credit history, you will be able to take out a payday loan. Hence, for people looking for immediate financial solutions, these are the only source of cash when they are in need.

Are the Payday Loans a Boon or a Curse?

Although payday loans are easy to obtain and do not involve too much hassle, they are not without their vices. These loans come with an extremely high rate of interest. The loans are not secured, and the lenders do not check your credit rating. Thus, they charge you a high-interest rate.

So, it will always be better for you to check your affordability before taking out a payday loan, and you should never miss payments on the payday loan.

The payment procedure is also excruciating. If you can’t make your payment on time, banks will charge you an added fee for bounced checks, besides the cost of your loan. As a result, it is likely to fall into payday loan debts.

You have to consider payday loan help to come out of the debt in such situations. Failure to make these loan payments might result in check fraud or the lender threatening criminal prosecution.

Why Should You Not Borrow from Your 401(K)?

Simply put, when you borrow from your retirement account, you forfeit the opportunity to earn a profit on your investment. If you can’t repay the loan, you will be required to pay taxes on the amount borrowed and a 10% penalty for the early withdrawal.

You Stop Saving Money When You Draw Cash

Most 401(k) plans do not allow you to make further contributions to the plan until you repay the money you’ve taken out. Thus, when you decide on borrowing against your retirement plan, you must make sure that you restrict your saving ability and mar your 401 (k) account from appreciating value.

The full feature of a retirement plan is to save money for the future and not use it as an emergency account before you retire.

Time May Start Working Against You

The entire logic behind investing money in long-term plans is to make time work in your favor. According to most calculations, your money will double every eight years if you continuously contribute to your 401 (k) account.

Thus, if you take out a loan against your 401 (k) account and use it to purchase or renovate your home, you may lose the opportunity to double your money. You will miss the chance to let your cash appreciate with time.

You Lose the Cushion of a Savings Account

Taking out a loan from the 401 (k) plans must be done only when facing dire financial consequences. If you take out the money to pay back your high-interest loans, you may not have enough money to support yourself during earnest financial needs.

So, how can you repay your existing debt without taking out any loan?

Learn the Debt Snowball Method and Apply

You can repay your debts by following the debt snowball method:

List your debts in ascending order, beginning with the lowest balance and ending with the one with the highest ratio.

Then you’ll apply any extra money you make to the first loan on the list.

Make only the minimum payments on the remaining debts on your list.

When you’ve paid off the first debt, transfer the total payment amount to the debt with the next lowest balance, adding any extra money until that one is paid off. Keep doing this until all the debts are paid off.

Stop Unnecessary Spending to Save Money for Debt Payments

You might be able to save a good amount if you reduce your consumption. Keep an eye on your spending habits. You might be surprised at how frequently you use your credit card to pay for things you don’t need.

You Could Look into a 0% Balance Transfer Card

Another option is a balance transfer credit card with a no-interest introductory period if you have good credit. You should have a good income to make sure you pay off the balance on time.

Look for a Professional Debt Relief Service

A good debt consolidation program can help you get out of debt in a few years.

Suppose you believe that the total outstanding balance exceeds half of your income and will be unable to pay even after a decade. In that case, you should seek professional debt relief assistance before taking out a 401(k) loan.

Attend a credit counseling session to determine which debt relief option is best for you. You can choose between debt consolidation and debt settlement.

If you find yourself in a real emergency and your only way out is a loan against your 401(k), then that might be a solution to explore. In any other situation, that should not be your first payment choice.

Let’s Have a Conversation:

What is your current debt status? Have you used payday loans or a loan against your 401(k)? Which tool would you say worked best in your situation?

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The Author

Lyle Solomon has extensive legal experience as well as in-depth knowledge and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998, and currently works for the Oak View Law Group in California as a Principal Attorney.

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