I had lunch with a buddy today who just finalized his divorce. As a parting gift, the former wifey left him with a nice, hefty credit card bill to the tune of ~$55K. She was an AU on all of his cards, and he estimates about $50K was her spending (jewelry, vacations with friends, clothes, tuition bill for her sister, etc.).
I am still floored that he had to sell their house (which he bought while he was single) and split almost all of their assets since it was considered communal property. Yet he gets stuck with the entire credit card debt (which she ran up). Why would assets be “communal”, but not debt?
Anyway, the divorce has left him pretty much broke. He was able to retain one asset: his 401k which has about $65,000. He knows about some of my past credit issues and was asking my advice on how to pay the CCC’s back. He’s been thinking about cashing in most of his 401K and take the early withdrawal penalty. I advised him strongly against this course as the tax penalty is killer (not to mention it would take him a long time to replenish those funds). He’s 40 years old…
But I started thinking: can he borrow from a bank using his 401K as collateral? He has good credit (other than the fact that most of his cards are maxed out) and has a decent income. He tried applying for a debt consolidation loan, but was denied (scores too low).
Does anyone have experience with using 401k/IRA as collateral for debt consolidation? Are there any rules/regs in order to use this type of asset?
@Anonymous wrote:The purpose of collateral is to secure the loan in case of default. There would be no way for the lender to seize the monies in a 401k in case of default. Hence, why he was able to keep all of his 401k without giving up half to the money vacuum he divorced! Therefore, it cannot be used. It can be considered as an asset when applying for credit, but cannot be put up for collateral. Early withdrawing is a huge mistake. The early withdrawal hit he will take won't leave enough to pay the debts. On top of that, it can push him into a higher tax income bracket leaving him with a big tax bill come April.
Thx jd352! I figured this may not be possible (otherwise I'm sure it would have been discussed frequently on the forum). I feel bad for the guy, and I was adamant he should not touch his 401k (for the reasons you stated above). The last thing he wants to do is get in trouble with the mother of all collection agencies---the IRS.
I did advise him to try to at least pay down his cards so they weren't in the danger zone (he said all but one card is >90% UTL).
I went through a similar situation about 10 years ago.
The credit cards I got stuck with I didn't know existed until the final division of property.
It is smart to assume the debts and make sure they are paid as long as you get full credit
for the assumption. Otherwise, if put in your ex's pile and she doesn't pay them, they will come
looking for you for the entire amount. A divorce property settlement doesn't absolve you of
the communal debt, in the case it isn't paid.
Can your friend get a loan against his 401K ? The rules vary with different 401K programs. Many,
but not all, allow you to borrow up to half the balance and pay your 401k back with interest. Some
programs force you to suspend contributions and match while there is a loan outstanding, but
many don't.
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