As Student Loan Servicers Leave, Here’s What Borrowers Need to Know

Federal student loans have a standard repayment plan of 10 years.
Many websites allow you to compare rates across companies to refinance your loan, assuming you have a steady income and good credit. Some servicers will also reduce your interest by 0.25% if you set up an automatic payment.
The pause on payments that started in March 2020, known as student loan forbearance, is coming to an end on January 31, 2022. That means 43 million borrowers are due to start paying on their loans again early next year.

  • In July, FedLoan said it didn’t plan to renew its contract with the government, which ends in December. More than 8 million borrowers will be affected and transitioning to a new servicer.
  • Granite State Management & Resources services loans for 1.3 million borrowers and also will not be renewing its contract with the Department of Education at the end of 2021.
  • And, in September, Navient – one of the largest servicers in the country  – will transition its 6 million student loan accounts to another servicer, Maximus.

The best way to pay off debt? Make more money!
If you’re struggling to make those payments, you have several payment plan options that include an Income-Based Repayment Plan, Income-Contingent Repayment Plan, Pay-As-You-Earn Plan, and a Revised Pay-As-You-Earn Plan.
Here’s a quick breakdown:

What Does This Mean for Borrowers?

“Some servicers have decided to exit the program rather than contend with these new realities. Others have caught the spirit of what we are intending and have embraced a new normal of putting borrowers first.”
Ready to stop worrying about money?
With a zero based budget, you’re in charge of how much you spend on debt every month, unlike percentage-based budgeting. If you’re attacking that student loan debt, you can change the percentages based on your other monthly expenses.
Yes, that’s no fun. But if you really want to get out of student loan debt, and you want to do it faster, some other stuff has to go.

How to Tackle Student Loan Repayments

In theory, they’ll just be making payments to a new loan servicer. No big deal, right? The problem, though, is the short transition time. The timing isn’t ideal.

1. Build an Emergency Fund.

“We can expect that many, many borrowers will not be eager to return to repayment when they have been led to believe, or even to hope, that was never going to happen,” he said. “Getting over that psychological hurdle with millions of Americans may be a much harder job than we know.”
Source: thepennyhoarder.com

2. Determine Your Eligibility for Income-Driven Repayment Plans.

A zero-based budget is built to pay off debt fast.
Here are a few actions we suggest to pay down your loans.

3. Lower Your Interest Rates.

Privacy Policy
Richard Cordray, COO of Federal Student Aid, recently gave a policy speech to the Education Finance Council. His remarks were given to Politico.
If you have a private loan, it never hurts to call your servicer, explain your situation, and ask for a new, lower rate.

4. Choose a Debt Payoff Method

Get the Penny Hoarder Daily
One month you can use a quarter of your monthly income, and the next month you might go wild and use half. It’s up to you. Plus, any money leftover you can also put toward that debt.
A ,000 rainy day fund will help you pay cash for those everyday emergencies that could really slow down paying off your loans. When it comes to student loans and their accompanying interest, every matters.

5. Make Sure You Have a Budget.

Sometimes just making a simple, concrete plan helps with motivation. You can see exactly what your payment future looks like, and you know exactly what you need to do to get out of debt.
He said in the speech that part of renegotiating with the loan servicers will be new performance and accountability metrics. According to Cordray, that didn’t sit well with some servicers, so they split.
Lowering the percentage you pay in interest always helps, no matter how small of a decrease. Federal loans are typically lower interest than private loans, but you can still look into lowering those rates.
“I need to pay something off, and you’re telling me to save?” Yes!

6. Find a Side Gig.

Whether it’s tutoring, freelancing, working odd jobs, teaching ESL, online transcribing, and even renting your friendship, there are myriad ways to make some extra money. In fact, we have 50 unique ideas to get you started.
The debt avalanche is one such plan. You start with your highest interest loan, then focus on putting as many extra payments/cash toward that loan. Once it’s paid, you move onto the next highest interest loan. The avalanche continues until you’re out of debt.

7. Cut Expenses.

The student loan servicing industry has had better days. The exodus of student loan servicers is just one of many that have plagued the student loan industry in recent years. Our best advice? Do everything you can to get out of student loan debt as quickly as possible and eliminate this ongoing financial headache from your life.
Another plan is the debt snowball method. With this plan, you start with the lowest balance first. Put everything toward paying it off, then move onto the next lowest balance. So an and so forth and you’re eventually out of debt. <!–

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Cordray said the payment pause is “an unprecedented challenge” because of the complications of restarting tens of millions of payments at the same time. He said that the political debate over student loan forgiveness hasn’t helped when it comes to borrowers’ expectations.

Why did my credit score drop after paying off debt?

Couple reviewing finances.

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

Paying off debt is wise and satisfying, so you may be surprised to find your credit score dropped after making a payment. Because credit scores are calculated using a variety of factors, the drop could have occurred for several reasons. The most common reasons credit scores drop after paying off debt are a decrease in the average age of your accounts, a change in the types of credit you have, or an increase in your overall utilization. 

It’s important to note, however, that credit score drops from paying off debt are usually temporary. In general, the benefits of paying off debt outweigh the downsides of a reduced credit score. If your debt has a high interest rate, the amount you owe will continue to grow over time, so reducing the balance or paying it off entirely could save you a significant amount of money.

Still, you can make strong financial decisions by understanding why paying off debt can reduce your credit score in the short term—and you can work toward a higher credit score over time.

Your credit score is calculated using several factors: payment history, credit utilization, credit age, number of inquiries and types of credit. Paying off debt could affect one or more of these factors, which could explain the drop in your score.

Read on to learn why your credit score may have dropped after you pay off debt, other reasons your credit score may be lower, and a few ideas for improving your credit score. 

How paying off debt could affect your credit score

Your average account age may have decreased

One ranking factor for your credit score is the length of your credit history, which includes the average age of your accounts. 

If you pay off your oldest account and close it, the average age of your accounts will drop, which could lead to a decrease in your score.

While closed accounts will stay on your credit report for seven to ten years after you close them, they are viewed differently than open accounts. 

Over time, your length of credit history and average account age will increase, so the drop that comes from paying off debt is likely temporary.

You may now have fewer types of credit

Another ranking factor for your credit score is the types of accounts you have on your report. In general, the credit bureaus who report your credit history want to see that you’re responsibly using several different types of credit. 

For example, your credit report may list a few credit cards and an auto loan. If you pay off and close the auto loan, your credit mix now has less variety since it only contains credit cards. This could lead to a temporary drop in your credit score.

That said, it’s not necessary to go out of your way to take on as many different types of credit as possible. Instead, use different types of credit when you need them, making sure to pay on time. Over time, your credit score will recover with responsible use of credit.

Your credit utilization may have increased

An additional factor that affects your credit score is utilization, which is simply the amount of credit available to you that you’re actually using. For example, if your only account is a credit card with a $1,000 limit and you have a balance of $200, you’re using 20 percent of your available credit. 

In general, lenders want to see that you’re using 30 percent or less of your available credit, as this signals that you’re able to manage your finances without leaning too heavily on credit.

If you pay off a credit card debt and close the account, the total amount of credit available to you decreases. As a result, your overall utilization may go up, leading to a drop in your credit score.

As a rule of thumb, it’s often helpful to keep older accounts open even if you don’t use them often, unless they involve an annual fee or there’s another good reason to close them. 

Other reasons your credit score could drop after paying off debt

Although the most common reasons for a score drop after paying off debt are listed above, there are a few other possibilities.

Other reasons your score may drop after paying off debt

Here are some things to keep in mind if you notice a change in your score after paying off debt: 

  • You paid off an older collections account: In some cases, making payments on an old collections account can lead to the collection agency changing the date of the debt. Since the debt resurfaces as a newer account on your credit report, it may make a larger impact on your score.
  • Not enough time has passed since paying off the debt: The credit bureaus may not get information about your debt payment for 30 days or more, so you’ll want to check your credit report to see whether the account is marked as paid off.
  • Your score drop is unrelated to paying off debt: Although your credit score may drop after paying off debt, that may not be the reason your score dropped. Credit scores are a complicated calculation, and there could be many other reasons for a change in your score. For example, you may have applied for a new line of credit, have a missed payment on a different account, or have inaccurate information on your credit report.

In any case, if you notice a credit score drop, you’ll want to make sure to get a copy of your credit report. After looking at your report for each of the three credit bureaus—TransUnion®, Experian® and Equifax®—you’ll have a better idea of the information they’re reporting about you.

In addition to seeing whether your debt is shown as paid off, you’ll also want to pay close attention to any negative items or inaccurate information listed on your credit report. Unfair negative items can have a damaging effect on your credit score, and federal law allows you to dispute any items on your credit report that you can prove are inaccurate. 

Filing a dispute to challenge false information is an important part of the process of repairing your credit and improving your score. For support in looking over your report and disputing inaccurate information, consider working with a credit repair consultant at Lexington Law Firm, who can assist with every step of the process. Having an accurate and fair credit report is an important first step in working toward your credit score goals.


Reviewed by Alexis Peacock, Supervising Attorney at Lexington Law Firm. Written by Lexington Law.

Alexis Peacock was born in Santa Cruz, California and raised in Scottsdale, Arizona. In 2013, she earned her Bachelor of Science in Criminal Justice and Criminology, graduating cum laude from Arizona State University. Ms. Peacock received her Juris Doctor from Arizona Summit Law School and graduated in 2016. Prior to joining Lexington Law Firm, Ms. Peacock worked in Criminal Defense as both a paralegal and practicing attorney. Ms. Peacock represented clients in criminal matters varying from minor traffic infractions to serious felony cases. Alexis is licensed to practice law in Arizona. She is located in the Phoenix office.

Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.

Source: lexingtonlaw.com

Should I Save for a Down Payment on a House or Pay Off Debt?

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You need cash for a down payment to buy a house. But your existing monthly debt payments and credit also affect your ability to borrow, your interest rate, and the lender fees you’ll pay. Which says nothing of financial upsides and downsides to buying versus renting a while longer.  

So how do you choose between paying off your debts and savings for a down payment?

It depends on your personal finances, so consider the following factors while you decide how to prioritize your savings. 

How Debt Affects Your Mortgage Application

Before getting into the other factors that go into your decision, you first need to understand how lenders review your loan application. 

When you apply for a mortgage, the bank or broker looks at your income, your debts, your assets, and your credit history. They use this information to calculate how much to lend you, at what interest rate and points, and with what down payment. 

Debt Ratios

Mortgage lenders calculate two debt-to-income ratios when you apply: a “front-end” and “back end” ratio. 

Your front-end debt ratio is based solely on your housing expenses if you were to borrow money to buy a house. Lenders typically cap borrowers’ housing expenses at 28% of their gross monthly income. So, if you earn $5,000 per month, lenders limit your monthly loan payment to $1,400. Housing expenses include your mortgage principal and interest, property taxes, homeowners insurance, and any homeowners’ or condo association fees. 

Where it gets slightly more complicated is your back-end ratio, which includes all your monthly debt payments. Lenders usually cap borrowers’ back-end debt ratio at 36% of their gross monthly income. That includes not just your prospective mortgage payment, but all your other monthly debt payments including auto loans, personal loans, student loans, credit card minimum payments, child support, alimony, and any other obligatory payments. 

Continuing the example above, say you earn $5,000 per month, but you owe $500 each month on a car loan, $400 toward student loans, and $100 toward credit card balances. Since most mortgage lenders cap you at a 36% back-end ratio, that means a maximum of $1,800 each month going to all your debt payments combined. Since you already have $1,000 going toward other debts, lenders would only approve you for a mortgage with an $800 payment — including principal, interest, property taxes, homeowners insurance, and association fees.

By paying off one or more of those outstanding debts, you can qualify for a much higher mortgage loan. 

Credit

Your credit score and history determine your interest rate, lender fees, and down payment. While you can buy a home with bad credit, it costs far more, both in down payment and monthly loan payments. 

If you have bad credit, consider improving your credit score before you buy a home. Which you can start by paying off your other debts. 

That kills multiple birds with one proverbial stone: you eliminate debts, which increases the loan amount you qualify for, and boosts your credit score, which helps you qualify for a cheaper loan with a lower down payment. Wins all around. 

Down Payments & PMI

If you put down less than 20% when you buy a home, the lender requires you to pay for mortgage insurance. Among conventional loans, it’s called private mortgage insurance (PMI); among FHA loans, it’s called mortgage insurance premium (MIP). It can add $100 or more to your monthly payment. 

The distinction matters, because conventional loans allow you to remove PMI once you pay the balance down below 80% of your home’s value. However FHA loans no longer allow that — they require you to keep paying MIP for the entire life of your loan. That means you should avoid FHA loans if possible, and the better your credit score, the better your odds of getting a conventional loan. 

When you take out a conventional loan, you ideally want to put down 20% to avoid PMI entirely. It adds another wrinkle to the decision of whether to put more money toward a down payment or toward paying off debts. But even if you borrow more than 80% of the home price, at least you can remove PMI once you pay down your loan balance. 


Non-Mortgage Factors Affecting Your Decision

Your mortgage approval and loan terms aren’t the only factors that go into your decision. 

Consider the following as well, as you decide what makes most sense for you. 

Cost of Renting vs. Owning in Your Market

In some markets, it costs far more to own a home than to rent an equivalent one. And vice versa in other markets. 

Look no further than San Francisco. People love to complain about rents in San Francisco, but they’re a steal compared to home prices. 

The median rent for a three-bedroom home in San Francisco is $4,567 per RentData.org, while the median home price is $1,504,311 per Zillow. At a 4% mortgage rate for a 30-year loan, principal and interest comes to $7,182 per month. At a property tax rate of 1.1801%, property taxes on a median home come to $1,479 per month. Add another $200 for homeowners insurance and you have a monthly housing payment of $8,861 — nearly twice the cost to rent. And that says nothing of home maintenance and repairs, which renters delegate to their landlord. 

In markets where it costs more to own than rent, there’s little rush to become a homeowner. Prioritize paying off debts over saving for a down payment. 

How Long You Plan to Stay

American culture has built a mythology around homeownership. But as demonstrated above, it doesn’t always make sense. 

Nor are market rent and home pricing the only reason to rent. Renting allows flexibility: you only commit to one year at a time, if that. When you buy a home, it takes years to build enough equity to cover both your initial purchase closing costs and your subsequent selling costs. 

If you don’t know how long you want to live in your next home, rent rather than buy. Take the time to pay down debts and improve your credit score. 

That goes doubly if you’re thinking about buying a home with a partner, but you’re not 100% confident in your long-term future together. 

The Interest Rate on Your Other Debts

The interest rates on your other debts matter. The higher they are, the more urgently you should pay them off. A 5% interest rate on a car loan comes with far less urgency than a 50% rate on a loan from the mob, to use an extreme example. 

While you may not owe the mob, many Americans do carry credit card debts with interest rates ranging from 15% to 30%. Consider any loan with an interest rate in the double digits “urgent.” 

Bear in mind that it often makes sense to pay off one debt but not another before saving money to buy a home. For instance, if you have credit card debt at 25% interest and a car loan at 5%, consider paying off the credit card balance but leaving your car loan in place. 

Your Ability to Suspend or Reduce Other Debt Payments

Since the bank uses your minimum required payments to calculate how much loan you can afford, decreasing minimum payments may increase your loan amount without you having to pay off any debt. It works best with loans you want to keep, such as those with low interest rates.

For example, many student loans permit you to suspend or alter your payment plan for a year or two. That makes it easier to qualify for a larger loan without having to pay off any of the low-interest student debt.

With credit card debt, you can consider a balance transfer to a credit card with a lower APR rate or a promotional period free of any interest. Don’t open a new card just before you apply for your mortgage however, as this can temporarily ding your credit score.

Your Appetite for House Hacking

I don’t have a housing payment, and it makes a huge impact on my savings rate. 

Consider getting creative and exploring ways to house hack. In the traditional model, you buy a multifamily property and move into one unit, while renting out the others. Your neighboring tenants ideally pay enough in rent to cover your monthly mortgage payments and some of your maintenance costs. 

Alternative house hacking models include bringing in housemates, renting out a basement or garage apartment, renting part of the home on Airbnb, or any number of other house hacking tactics. 

I’ve known renters who found ways to house hack. But you have more options when you own your own home. 

If the idea appeals to you, and you’re willing to do some research on how to make it happen, buying a home sooner rather than later often makes sense. 

Access to Other Funding Sources for Your Down Payment

Some people have family members who might help them out with a down payment — but would never give them money to pay off credit card debt that they racked up through their own financial mismanagement. 

In those cases, you can put your own savings toward paying off debts, and accept loans or gifts from family members to help with your down payment. Keep in mind that conventional mortgage loans don’t technically allow you to borrow the down payment, but they do allow gifts. 

You can also pull money from your retirement accounts to cover your down payment, tax- and penalty-free. Each retirement account comes with its own rules and limitations for withdrawing funds for a down payment, so do your homework. 

Research other creative ways to come up with a down payment. You might find that you can put your own savings toward paying off your debts, even as you raise your down payment elsewhere.

Tax Implications

I hesitated to even include this, because too many people overemphasize the importance of the mortgage interest deduction. But Uncle Sam does play favorites with homeowners and allows them to deduct the interest paid on their home mortgage each year, along with their property tax bill. 

That only helps you if you itemize your deductions, of course. If you take the standard deduction — as many more Americans now do, after it was raised by the Tax Cuts and Jobs Act of 2017 — the mortgage interest deduction doesn’t impact your taxes at all. The law also put a $10,000 cap on state and local tax deductions on your federal income tax return, limiting your ability to write off property taxes in high-tax cities. 


A Framework for Deciding Whether to Pay Down Debts or Save a Down Payment

First and foremost, reevaluate whether you should buy a home right now at all. Research rents versus homeownership costs in your area, and try this nifty rent vs. buy calculator from Realtor.com. Ask yourself how long you plan to stay in your next home, and if you don’t know or if it could be less than three years, continue renting for now while you become debt-free. 

If you decide that you definitely want to buy, calculate your back-end debt ratio, and how much money it leaves for a mortgage payment. Don’t forget property taxes, insurance, and homeowners’ association fees. If a 36% cap doesn’t leave you with much room for a housing payment, consider paying off debts. Use the free mortgage limit calculator from Chase to help you run the numbers. 

If you’re paying more than 8% to 10% on some of your debts, consider paying them off before saving for a home. Try the debt avalanche method to knock out your highest-interest debts quickly. 

In contrast, if you plan to house hack, or if you can raise your down payment from money other than your own savings, consider prioritizing your down payment. Buying a home helps you even more if you itemize your deductions, but don’t base your decision on that factor alone. 

Don’t forget to leave yourself an emergency fund, so you don’t find yourself panicking when a $3,000 repair bill comes due 30 days after you settle on your new home. 


Final Word

As you run the numbers in the calculators above, be careful to avoid framing your future housing payment in terms of the most you can possibly afford. It’s a recipe for overspending on housing, and leaving no money for groceries, entertainment, or travel. 

Instead, ask yourself “What’s the least I can spend on housing and still be satisfied with my home?” By reframing the question, you’ll look for homes that meet your requirements rather than looking at homes that stretch your housing budget to their absolute limits. 

Better yet, skip that game entirely and either house hack or find a job that provides free housing. The suburban American dream of the white picket fence is overrated anyway. 

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Source: moneycrashers.com

7 Great Tools to Help You Get Out of Debt

Worried couple looking at bills in the morning at home with laptop and coffee
WAYHOME studio / Shutterstock.com

We’ve borrowed a lot. Collectively, we Americans owe $14.96 trillion, says the Fed.

Our mortgage balances make up the lion’s share — $10.44 trillion — but we also owe trillions in student loans, auto loans, credit card debt and other revolving credit accounts.

Are you among the millions of folks feeling the weight of that debt?

We’ve written tons of articles that can help you destroy debt, like “How to Pay Off $10,000 in Debt Without Breaking a Sweat” and “10 Ways to Lose Weight and Pay Down Debt — at the Same Time.” (Do a search for “Debt” at the top of this page, and you’ll find lots more.)

But there’s also help in the form of free or cheap apps and websites. Here are several of our favorites:

1. Tally

Credit card debt can be hard to shake. That’s where Tally comes in. This app automates debt management and makes it easy to save money, manage your credit cards and pay down balances faster.

Download the free app and add in your credit cards. If you qualify through a painless credit check — you’ll usually need a credit score of 580 or above — the app will offer you a low-interest line of credit. The interest rate, lower than the rates on your credit cards, will enable you to pay down your debt faster and through one simple payment.

“We are effectively buying [money to lend you] in bulk on behalf of our users and passing the majority of those savings to them,” says Jason Brown, company co-founder.

Tally then takes over the task of paying your cards with the line of credit. You just pay Tally.

Tally also has a debt calculator that can help figure out your “debt-payoff roadmap.”

2. Self

Build credit while you save with Self (formerly Self Lender).

Technically, you take out a loan, but you don’t get the money until you pay it off. No credit score is needed, and Self says it won’t do a “hard pull” credit check.

Here’s how Self works: You choose the free app’s plan that meets your budget, starting at $25 a month, with either a 12- or 24-month term. Your payment goes toward money held in your name as a certificate of deposit.

Each monthly payment is reported to all three credit bureaus. At the end, you’ve paid your loan and get the money from the CD and have built a better credit score. You can use that money to pay down debt.

“I wanted a simple way so that I could help my future self build credit and save money,” James Garvey, CEO and co-founder of the company, told American Banker.

3. Acorns

Invest your spare change with Acorns and save for retirement.

For $3 or $5 per month, you get either a personal or family plan. Both can be used to invest your rounded-up payments on purchases in exchange-traded funds (ETFs), growing your money over time. The family plan has the additional feature of an investment account for your kids.

4. Qoins

Like Acorns, Qoins rounds up your credit card spending to the nearest dollar and applies the money from the difference toward your outstanding debt, or sets it aside for saving, depending on your wishes.

You can choose to apply it to debts such as student loans, credit cards and mortgages.

Qoins users will pay off debt two to seven years early and on average save thousands of dollars on interest payments, its developers say.

Your cost is $2.99 or $4.99 a month, depending on whether you want one or more types of goals, and the amount is deducted from payments it sends you.

5. Debt Free

You can manage your debt with Debt Free, an app that helps you to organize, monitor and pay off your debts using what’s known as a “snowball plan,” in which you aggressively eliminate one debt at a time.

You can choose to first go after debts with the lowest balances, highest interest rates or just in whatever order you choose.

Debt Free also will calculate your overall debt-free date and payoff date for each debt as well as calculate interest and time savings with extra payments.

It will also send you notifications for payment due dates.

The 99-cent app (iOS only) includes three built-in calculators:

  • Payoff date calculator
  • Loan calculator
  • Mortgage calculator

6. Unbury.me

Unbury.me is a free online tool that allows you to create an account, list all of your debts and map out a payment plan to suit your needs.

You can choose from two methods:

  • Avalanche: Attack your debt with the highest interest rate first, then move to the second-highest and so on. This may save you the most money in the long run.
  • Snowball: Focus on your lowest balance first, then the second-lowest and so on. This is the right choice if short-term victories motivate you better to direct more money to your payment goal.

The tool also shows you how much faster you’ll pay off a debt by paying more than the minimum each month instead of just sticking to the minimum.

For example, a $5,000 balance with a $100 minimum monthly payment at 15.9% interest, it showed, would take seven years to pay off, and you’d pay about $3,250 in interest; at $200 a month, you’d be debt-free in just three years and pay only around $1,120 in interest.

7. MTN Solutions Center

Last but not least, if you are struggling with credit card debt and you need help, go to our Solutions Center, where our partner Debt.com can match you with the services you need. It can also help kill off tax or student loan debts, restore your credit, deal with debt collectors and more.

It looks for ways to get you out of high-interest debt and save money. You can request a free evaluation from a certified credit counselor to identify the best credit card debt solution for your situation. Solutions may include credit card balance transfers, debt consolidation loans, debt management programs, settlement programs or consolidated credit programs. If you’d prefer, you can also give Debt.com a call at 888-739-9616.

The site also offers free calculators, free expert advice and other free tools.

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

Source: moneytalksnews.com

Using Your 401K to Pay Down Debt

You have debt. But you’ve also got a stash of cash in your 401(k).

If you’re feeling overwhelmed by high-interest credit card balances, a student loan, and/or an auto loan, you might think taking money out of your 401(k) is a good way to pay down that debt and get it under control.

But is withdrawing money from your 401(k) to pay off debt a good idea? How would you go about doing it — and then paying it back?

What Are Some Options for Taking Money out of a 401(k)?

There are two basic options for taking money out of a 401(k): withdrawals and loans.

401(k) Withdrawal

A withdrawal removes money from your account permanently. You don’t pay the money back — but you can typically expect to pay taxes on the amount you withdraw. And, depending on your age, you may have to pay an early withdrawal penalty as well.

401(k) Loan

A loan lets you borrow money from your account and then pay it back to yourself over time. You’ll pay interest, but the interest and payments you make will go back into your retirement account.

There are pros and cons for each of these options. And the rules can vary depending on your age and what your employer’s plan allows. Here are some things to consider.

What Are the Rules for 401(k) Withdrawal?

Tax-deferred retirement accounts like 401(k)s, 403(b)s, and others were designed to encourage workers to save for retirement, so the rules aren’t super friendly for those who want to make a withdrawal before age 59½.

But depending on your financial situation, you may be able to request what the IRS calls a hardship distribution .

Employer retirement plans aren’t required to provide hardship distribution options to employees, but many do, so it may be worth checking with your HR department or plan administrator for details on what your plan allows.

According to the IRS, to qualify as a hardship, a 401(k) distribution must be made because of an “immediate and heavy financial need,” and the amount must be only what is necessary to satisfy this financial need. Expenses the IRS will automatically accept include:

•   Certain medical costs.

•   Costs related to buying a principal residence.

•   Tuition and related educational fees and expenses.

•   Payments necessary to avoid eviction or foreclosure.

•   Burial or funeral expenses.

•   Certain expenses to repair casualty losses to a principal residence (such as losses from a fire, earthquake, or flood).

You still may not qualify for a hardship withdrawal, however, if you have other assets you could draw on or some kind of insurance that will cover your needs. And your employer may require documentation to back up your request.

You probably noticed that credit card and auto loan payments aren’t included on the IRS list. And even the tuition expense requirements can be a little tricky. You can ask for a hardship distribution to pay for tuition, related educational fees, and room and board expenses “for up to the next 12 months of post-secondary education” for yourself, your spouse, your children, or your dependents. But you can’t expect to use a hardship distribution to repay a student loan from when you already attended college.

Are 401(k) Withdrawals Subject to Taxes and Penalties?

Even if you can qualify for a hardship distribution, it’s a good idea to plan to pay taxes on the distribution (which is generally treated as ordinary income). And, unless you meet specific criteria to qualify for a waiver , you’ll also pay a 10% early withdrawal penalty if you’re younger than 59½.

So, let’s say you’re 33 years old, and you have enough in your 401(k) to withdraw the $20,000 you need. Right off the top, unless you qualify for a waiver, you can expect to pay a $2,000 early withdrawal penalty. Then, when you file your income tax return, that 401(k) distribution will most likely be counted as ordinary income, so it will cost you even more. And if that added income bumps you into another tax bracket, you could end up paying even more.

But taxes and penalties aren’t the only costs to consider when you’re deciding whether to go the distribution route.

Since compound interest creates the potential for your initial investment to grow significantly over time, every dollar you take out now could mean several dollars less in retirement. Essentially, withdrawing from your 401(k) now is like borrowing money from your future self, because you’re losing long-term growth.

What Are the Costs Associated With 401(k) Loans?

You may be able to avoid paying an early withdrawal penalty and taxes if you borrow from your 401(k) instead of taking the money as a distribution. But 401(k) loans have their own set of rules and costs, so you should be sure you know what you’re getting into.

There are some appealing advantages to borrowing from a 401(k). For starters, if your plan offers loans (not all do), you might qualify based only on your participation in the plan. There won’t be a credit check or any impact to your credit score — even if you miss a payment. And borrowers generally have five years to pay back a 401(k) loan.

Another plus: though you’ll have to pay interest (usually one or two points above the prime rate ), the interest will go back into your own 401(k) account — not to a lender as it would with a typical loan.

You may have to pay an application fee and/or maintenance fee, however, which will reduce your account balance.

Of course, a potentially more impactful cost to consider is how borrowing a large sum from your 401(k) now could affect your lifestyle in retirement. Even though your outstanding balance will be earning interest, you’ll be the one paying that interest. Until you pay the money back, you’ll lose out on any market gains you might have had — and you’ll miss out on increasing your savings with the power of compound interest. If you reduce your 401(k) contributions while you’re making loan payments, you’ll further diminish your account’s potential growth.

Another risk to consider is that you might decide to leave your job before the loan is repaid. According to IRS regulations, you must repay whatever you still owe on your 401(k) loan within 60 days of leaving your employer. If you fail to pay off the outstanding balance in that time, it will be considered a distribution from your plan. And when tax time rolls around, you’ll have to include that amount on your federal and state tax returns, where, typically, it will be considered ordinary income.

If you’re under age 59½ and the loan balance becomes a distribution, you may also have to pay a 10% early withdrawal penalty.

There may be similar consequences if you default on a 401(k) loan.

What Are Some Ways of Minimizing Risks to Your Retirement?

If you decide using a 401(k) to pay off debt is your best (or only) option, here are a few things that could help you lower your financial risk.

•   Not using your high-interest credit cards once you use your 401(k) to pay them off. If you continue to use your credit cards, and then have credit cards and the 401(k) loan payments to make every month, you could end up in even more financial trouble.

•   Continuing to make contributions to your 401(k) while you’re repaying the loan — at least enough to get your employer’s match.

•   Not overborrowing. Creating a budget could help you determine how much you can comfortably pay each quarter while staying on track with other goals. And try to stick to taking only the amount you really need to dump your debt and no more.

Why Do People Use Their 401(k) to Pay Down Debt?

Although there are significant costs involved in taking money out of a 401(k) to pay debt, many people still do it. It can seem like a good option if you have high-interest debt like credit card debt and you have to face those bills every month. If you have lower interest debt like student loans, personal loans, auto loans, or a home equity line of credit (HELOC), then the early withdrawal penalty and other consequences may be a deterrent.

But if you’re paying high interest on your current debt, or if you have debt payments due and no way to cover them, using your 401(k) might seem better than the risks of missing payments on those bills. Late payments can rack up fees, interest, and can ding your credit score. And if you default on a debt, that can have even more dire consequences, potentially including court actions and wage garnishment — depending on the type of debt and the creditor or lender. You can’t exactly wait it out and count on winning the lottery or inheriting money from some long-lost relative.

If your credit score ends up damaged due to late payments, that, too, could have a huge impact on your finances. Having a low credit score can make it more difficult to get loans in the future. You might have to pay a higher interest rate or there might be limits on how much you can borrow.

Given the dire consequences of doing nothing, using your 401(k) to pay off debt might seem like an attractive choice. But before you contact your HR department or plan administrator to request a loan or withdrawal, you may want to take time to look at some other options that could help you repay your debts.

What Are Some Alternatives to Taking Money Out of Your 401(k)

When it comes to paying down debt, your 401(k) isn’t the first or only place you can look for relief. There are some solid alternatives.

For example, refinancing your debt might be an option. When it comes to things like student loans or auto loans, you might be able to get a lower interest rate than you’re currently paying.

This may be especially true if your credit score or income has improved since you first took out your loan. If you took out educational loans when you were still a student, for example, you’re likely making more money now and might have built up a credit history that could make you eligible for a better deal.

If you have federal student loans and are still working toward that dream job (and salary), you could look into income-driven repayment plans that limit the amount that you pay each month to a certain percentage of your monthly discretionary income — which could help keep your monthly payments more manageable.

Many of these plans will also forgive any remaining balance on your federal student loans after 20 to 25 years of qualifying, on-time payments — something that you won’t be able to take advantage of if you pay off your loans with your 401(k).

If you still need help, you could look into whether you qualify to have your federal student loans put into forbearance or deferment (although you’ll want to consider these programs carefully, as you may still be responsible for any interest that accrues).

If you have credit card debt or other high interest debt, you could look into a credit card consolidation loan. Debt consolidation loans are loans designed to pay off your current loans or credit cards, ideally at a lower interest rate or with more favorable terms.

You can get these loans from a bank, credit union, or online lender, often by filling out a quick form and sending a few scanned documents. But it’s important to remember that this is still taking on debt, even if it’s debt with different terms.

One critical thing to remember when using a personal loan to refinance or consolidate debt is that you may have the option to extend the length of your loan, which may reduce your monthly payments and free up some near-term cash flow.

While extending your loan term means you’ll likely pay more in interest over the life of your loan, it might be a worthwhile move to ensure you can cover your debt payments.

The Takeaway

It may not have ever crossed your mind, when you opened your 401(k), that you’d use it for anything other than retirement. And though it may be tempting to tap it now, especially if you’re facing a daunting amount of expensive debt, that’s a decision with both short- and long-term consequences. Before you use your 401(k) to pay off debt, you may want to consider other available alternatives. With a SoFi Personal Loan, for example, you might be able to get a do-over on that debt and a more manageable monthly payment.

Learn more about personal loan options with SoFi for consolidating debt.


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SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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Source: sofi.com

Using a Personal Loan to Pay Off Credit Card Debt

People talk all day long about their workouts, favorite apps, and their love lives, but bring up the subject of money, especially credit card debt, and suddenly everyone clams up.

But just because we don’t talk about debt doesn’t mean it’s not an issue. After all, the average American household carrying a credit card balance has over $5,500 in credit card debt in 2021. But how do you pay off credit card debt? One method to consider: taking out a personal loan.

How Using a Personal Loan to Pay Off Credit Card Debt Works

Personal loans are a type of unsecured loan that a borrower can take out for almost any purpose, including paying off credit card debt. Loan amounts can vary by lender and will be paid to the borrower in one lump sum after the loan is approved. The borrower then pays back the loan — with interest — in monthly installments that are set by the loan terms.

Many unsecured personal loans come with a fixed interest rate that won’t fluctuate or change over the life of the loan. An applicant’s interest rate will be determined by a set of factors, including their financial history, credit score, income, and other debt, among other factors. Typically, the higher an applicant’s credit score the better their interest rate will be, as they may be seen as a less risky borrower. Lenders may offer individuals with low credit scores a higher interest rate, presuming they will be more likely to default on their loans.

When using a personal loan to pay off credit card debt, the loan proceeds are used to pay off the cards’ outstanding balances, consolidating the debts into one loan. Ideally, the new loan will have a much lower interest rate than the credit cards. Consider that the average credit card interest rate is about 16% , while the average personal loan rate is about 9.5% , according to the Federal Reserve. By consolidating credit card debt into a personal loan, a borrower’s monthly payments can be more manageable and cost considerably less interest.

Finally, using an unsecured personal loan to pay off credit cards also has the benefit of ending the cycle of credit card debt, without resorting to a balance transfer card.

Balance transfer credit cards are just credit cards that usually have an introductory offer of a low rate (or a 0% rate) on balance transfers to the new card. This might seem like an appealing offer. But if the balance isn’t paid off before the promotional offer is up, the card holder could end up paying an even higher interest rate than they started with. Balance transfer cards often charge a balance transfer fee, which could ultimately increase the total debt.

Taking Out a Loan to Pay Off Credit Card Pros and Cons

While on the surface it may seem like taking out a personal loan to pay off credit card debt could be the best solution, there are some potential drawbacks to consider as well. Here’s a look at some of the pros and cons.

Pros Cons
Lower interest rate: Personal loans may charge a lower interest rate than high-interest credit cards. Consider the average interest rate for personal loans is under 10%, while credit cards charge over 16% on average. Lower rates aren’t guaranteed: If you have poor credit, you may not qualify for a personal loan with a lower rate than you’re already paying. In fact, it’s possible lenders would offer you a loan with a higher rate than what you’re paying now.
Streamlining payments: When you consolidate credit card debt under a personal loan, there is only one loan payment to keep track of each month, making it less likely a payment will be missed because a bill slips through the cracks. Loan fees: Lenders may charge any number of fees, such as loan origination fees, when a person takes out a loan. Be mindful of the impact these fees can have. It’s possible they will be costly enough that it doesn’t make sense to take out a new loan.
Pay off debt sooner: A lower interest rate means there could be more money to direct to paying down existing debt, potentially allowing the debtor to get out from under it much sooner. More debt: Taking out a personal loan to pay off existing debt is more likely to be successful when the borrower is careful not to run up a new balance on their credit cards. If they do, they’ll potentially be saddled with more debt than they had to begin with.
Credit score boost: It’s possible that taking out a personal loan could boost the borrower’s credit score by increasing their credit mix and lowering their credit utilization by helping them pay down debt. Credit score dip: If closing the now-paid-off credit cards after taking out a personal loan is a temptation, perhaps reconsider doing so. Closing credit accounts that have been on a person’s credit report for some time could shorten their length of credit history and possibly negatively affect their credit score.

So You’ve Decided to Apply for a Personal Loan to Pay Off a Credit Card. Now What?

The steps for paying off a credit card with an unsecured personal loan aren’t particularly complicated, but having a plan in place is important.

Getting the Whole Picture

It can be scary, but getting the hard numbers — how much debt is owed overall, how much is owed on each specific card, and what the respective interest rates are — can give a sense of what personal loan amount might be helpful to pay off credit cards.

Searching Personal Loan Options

These days, most — or all— personal loan research can be done online. A personal loan with an interest rate lower than the credit card’s current rate is an important thing to look for. Origination fees, which can add to a person’s overall debt and possibly throw off their payoff plan, is another thing to watch out for.

Paying Off the Debt

Once an applicant has chosen, applied, and qualified for a personal loan, they’ll likely want to immediately take that money and pay off their credit card debt in full after they receive the loan proceeds.

The process of receiving a personal loan may differ. Some lenders will pay off the borrower’s credit card companies directly, while others will send the borrower a check that they’ll then have to deposit and use to pay off the credit cards themself.

Hiding Those Credit Cards

One potential risk of using a personal loan to pay off credit cards is that it can make it easier to accumulate more debt. The purpose of using a personal loan to pay off credit card debt is to keep from repeating the cycle.

Consider taking steps like hiding credit cards in a drawer and trying to use them as little as possible.

Paying Off Your Personal Loan

A benefit of using a personal loan to consolidate credit card debt is that there is only one monthly payment to worry about instead of several. Not missing any of those loan payments is important — setting up a monthly reminder or alert can be helpful.

Applying for a Personal Loan to Pay Off Credit Cards

With online applications, the process for getting a personal loan can be quick and easy, and some lenders may provide live customer support.

Applying online typically doesn’t take more than a few minutes. And there are more options than ever with innovative fintech startups doing what they can to make the process of refinancing your credit card debt quick and easy.

Again, there’s also the potential for saving. Of course, everyone’s situation varies, but you can use SoFi’s credit card interest calculator and personal loan calculator to do the math on your own.

Budgeting Debt Payoff

Before embarking on paying off credit card debt, a good first step is pulling together a budget, which can help a person better manage their spending. And they might even find money in their budget to put towards that outstanding debt.

If a person has more than one type of debt, for instance, a mortgage, student loan, and maybe a car loan, they may want to think strategically about how to tackle them.

Some finance gurus recommend taking on the debt with the highest interest rate first, a strategy known as the avalanche method. As those high-interest-rate debts are paid off, there is typically more money in the budget to pay down other debts.

Another approach, known as the snowball method, is to pay off the debts with the smallest balances first. This method gives a psychological boost, with small wins early, and over time can allow room in the budget to make larger payments on other outstanding debts. Of course, for either of these strategies, keeping current on payments for all debts is essential.

Ready for a Personal Loan to Pay Off Credit Card Debt? Use SoFi Today!

SoFi Personal Loans have low interest rates and fixed monthly payments, which can be helpful when paying off high-interest debt. The online application is quick – find your rate in just two minutes without any commitment to continue. If you’re approved, the funds are deposited directly into your account.

View your rate. Earn $10.
Because you deserve a more rewarding personal loan.

The Takeaway

High-interest credit card debt can be a huge financial burden. If a person is only able to make minimum payments on their credit cards, their debt will only increase, and they’ll find themselves in a vicious debt cycle. Personal loans are one potential way to end that cycle, as a tool to pay off debt in one fell swoop and hopefully replace it with a single, more manageable loan.

Remember, however, personal loans aren’t for everyone. While they typically have lower interest rates than credit cards, they are still debt and should be considered carefully and used responsibly.

Ready to get rid of your credit card debt? Check your rate on a SoFi personal loan in just a few minutes.


SoFi Loan Products
SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal.

Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. A hard credit pull, which may impact your credit score, is required if you apply for a SoFi product after being pre-qualified.
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Source: sofi.com