QUESTION: Stephen and his wife have about $12,000 in credit card debt, and they owe another $80,000 in student loans. Their kids’ education also runs about $1,000 a month, all on a combined yearly income of $100,000. He calls in to ask Dave if it’s acceptable to take a loan against your 401(k) to clean up the credit card mess. Dave doesn’t like the idea, and he explains why it’s a bad plan.
ANSWER: I don’t recommend that you do that, and here’s why. Your 401(k) should be invested in good mutual funds. When you take the money out in a loan, they pull it out of the mutual funds and you’re paying yourself a five percent interest rate instead of receiving what the mutual funds are paying, which should be 10, 12, 15 percent — whatever the market is doing. So you’re missing out on good rates of return.
But that’s not the biggest reason. The biggest reason is when you leave your company, and you will leave — whether it’s when you get a better job, get fired, or you die — that loan is considered an early withdrawal. If you don’t repay it within 60 days, you get hammered with a 10 percent penalty plus your tax rate. It can end up being half of the account.
No, I wouldn’t do that. The good news is that it’s only $12,000. I would tighten up the budget, and do something to increase your income — have a big garage sale, and sell so much stuff the kids think they’re next. The $80,000 in student loans is what’s killing you, not the credit card debt. You need to work a serious plan to get out of debt, and that always includes living on a tight budget.
QUESTION: Wes asks Dave’s opinion on paying cash for a “tiny house.” While the answer may not be cool, it does make sense from a long-term and short-term point of view.
ANSWER: This is a very un-hip thing to say, but I would not buy a tiny house. The problem with the tiny house idea is that there’s no track record on it, and it could be a fad. Another problem is that you’d have a very tiny market when it comes time to sell your tiny house. Translation? They probably won’t go up in value. They may actually go down in value.
There’s a thing in economics called the supply-demand curve. The higher the supply is versus the demand, the lower the price. The higher the demand is versus the supply, the higher the price. The tiny house has a tiny demand, and it doesn’t have a broad market appeal. It only has an appeal for early adopters, and people who think they’ll never be able to afford a house, or people who think it’s cool — which is an even lower appeal. It’s not got a broad appeal when you get ready to sell it, and thus you have a problem.
I have a friend who built a $4 million lake house in an area full of $600,000 houses. The market for $4 million houses on that lake is tiny. He likely will never sell it, and if he does he will sell it cheaper than he would if it were a $4 million house parked among other $4 million houses. So, he gets to live with this house a while. He did not build it wisely in terms of resale. Where there’s a low demand for something, it drives the price down. That’s the problem with the tiny house movement.
If you think I’m wrong, and enough people buy tiny houses and they become a real part of our culture, then maybe they’ll do okay. But it’s an unproven product line. It’s an unproven concept that appears to be a fad. So, I wouldn’t buy a tiny house. If you could sell me a tiny house at half of its current value, I still wouldn’t buy it because I’m afraid it would drop to a fourth of its current value. There’s no proven record of these things going up in value.
Paying cash for something that goes down in value versus buying something that goes up in value, that’s a bad deal. At that point, paying cash for it doesn’t make it smart.