I have an opportunity to retire an outstanding debt

[jdesim1]

I have an opportunity to retire an outstanding debt (promissory note) for half the balance due. The note outstanding balance is $21,375 which I have been paying back at $125/month. It is the last debt from a short sale of my home two years ago. I can settle it for $10,687. I do not have savings enough to cover that amount.
Would it be a good idea to take a short term (36 month) loan from my 401k to settle this note? I realize that 401k loans are not usually the best way to go but the long term savings are appealing.
What other questions should I be asking? What downside is there?

[cardtrick]

If you got an offer for 50% off, it means there is room to haggle. You could probably bring it down a lot more. Start by offering 15% of the balance and go from there. It might seem low but you'll be surprised at how low they'd be willing to go.

And given the situation, I'd do the deal by borrowing from my 401K. The return you'd be getting is pretty good.

[snafu]

What are the income tax implications of paying off a loan that has been reduced by half or more? What are you willing to give up short term to payback the sum to your 401K as quickly as possible? What fees and interest rate would be required in spite of the fact that you are borrowing your money?

[Retired To Win]

I know that when you settle a credit card debt for less than the amount owed, the credit card company will report the forgiven difference to the IRS, which in fact treats that difference as income received. So if you do this deal, factor in that you will be expected to pay federal income tax (at your marginal rate, of course) on the amount by which that original debt is reduced.

Good luck,

Retired To Win
making the most of my time and my money

[disneysteve]

I can settle it for $10,687. I do not have savings enough to cover that amount.

It doesn't matter what the settlement offer is if you don't have the money to pay it.

No, you should not borrow from your 401k. Go back to the lender and make a counter offer based on what you do actually have available and let them know that's all you have. If they accept it, great. If not, keep making your monthly payments and building your savings and then in a few months, make another settlement offer. Keep doing that until they accept your offer.

[dczech09]

Borrowing from a 401k should only be done in an emergency, like avoiding bankruptcy. If you borrow and then quit or lose your job, you will have 60 days to pay back the 401k loan. If you do not pay it back, you with have to pay taxes plus a 10% penalty.

Also, when you settle a debt for less than you owe, the amount that is forgiven becomes taxable as income. So you would have to make sure you have enough to cover the taxes on the forgiven amount.

This deal would potentially result in a huge tax bill. So no I would not do it. As DS pointed out, save up some money and then try settling in a couple of months. They're not going anywhere. Not to mention, the longer you wait to settle, the more valuable a settlement will become to a collector (which makes it likely that they will accept less in the future).

With all of this having been said, please be aware of the credit implication that this has. A settlement on your credit history will look VERY unfavorable for you.

Do you have the means of paying off your loan over the course of the next few years? At a rate of $125 per month, this loan will take a VERY long time to pay off. Is it possible to pay more and get rid of it the "honest way" sometime down the road? I ask because settling is only for people who do not have the money. If you have the ability to repay your debt, then you should.