I often read Dave Ramsey’s Column in the Erie Times-News. I sometimes agree, and sometimes disagree, with his views. It was no surprise when I both agreed and disagreed with advice he gave to a 23-year-old letter-writer whose letter appeared in a recent edition of the Erie Times-News.
The young writer wanted to consider cashing out his $11,000 401(k) to help pay off his $15,000 debt. Ramsey correctly noted that at a 20% tax rate and with a 10% penalty, it was like taking out a loan at 30% to pay off his debt. I agree that it does not make a lot of sense.
But then Ramsey added, “… unless it’s the only way to avoid foreclosure or bankruptcy.”
I respectfully disagree.
There are different kinds of consumer bankruptcy that could help, notably Chapter 7 and Chapter 13. Chapter 7 is a way of eliminating debt and Chapter 13 is a way of reorganizing your debt to pay what you can instead of what is owed (in some cases). Either could be a viable alternative to “borrowing at 30%,” the effect of closing out your 401(k). Either could save you lots of money and/or significantly improve your cash flow.
But what about your credit, you may ask? Here’s the scoop: Chapter 7 is on your credit report for 10 years, but you start rebuilding your credit immediately upon the completion of the case, which is normally over in four to five months. You should be able to finance a car almost immediately as long as you are working. Within two years, you should have decent credit all around, as long as you have done your homework and haven’t defaulted on anything. And within three years, most real estate brokers will tell you that buying a house is now a reality.
Chapter 13 is a bit different. It is on your credit report for seven years, but for three to five of those years, you are in the Chapter 13 Plan so you will not be able to start rebuilding your credit until the Chapter 13 matter has concluded. That being said, the relief you get with the lower payments more than compensates for any loss of credit for most of our clients. And remember one important thing: credit is someone else’s money. Our goal is to get you to the point where you are living on your money.
So Dave, good advice, up to a point. But don’t discount the possibility that people might find either Chapter 7 or Chapter 13 might be a good solution.