Tapping Retirement Savings to Pay Off Defaulted Auto Loans

Lots of folks are struggling with debt from auto loans gone bad these days. With job losses and pay cuts from the pandemic, it can be really hard to keep up with car payments. Before you know it, you’ve missed a few payments and your auto loan goes into default. Now the repo man is knocking at your door to take back your car, but you need it to get to work! What can you do?

Some people think about taking money from their retirement savings like a 401(k) or IRA to get caught up on the payments. This can help you avoid defaulting or losing your car if you’ve already defaulted. But is it a good idea to tap into your retirement funds? Let’s take a look at the pros and cons so you can make an informed decision.

The Upsides

Using retirement money to pay off defaulted auto loans can definitely help in a pinch. Here are some potential benefits:

• You may be able to catch up on missed payments and avoid defaulting on the loan. This can help you keep your car.
• If your auto loan has already gone into default, the money can potentially help you repay the loan and get your car back if it was repossessed.
• You’ll avoid the stress and embarrassment of having your car repossessed if you can get caught up on payments.
• Paying off the defaulted loan may help improve your credit score over time if you can get back in good standing.
• You’ll be able to keep reliable transportation to commute to work and take care of your family.

As you can see, tapping retirement funds to salvage a defaulted auto loan can be a lifeline that helps you hold onto your car. For many folks, this is their most valuable asset besides their home. Losing it creates a huge hardship, so the retirement money can really help in the short term.

The Downsides

While using retirement money to pay off defaulted car loans has some advantages, there are also important downsides to consider:

• You’ll lose out on that money’s future growth potential. Retirement accounts grow tax-deferred over decades.
• You may face taxes and penalties for early withdrawal if you’re under age 59 1/2.
• You’ll have less money saved for retirement, which means you may have to work longer.
• If you lose your job later, you’ll have depleted retirement savings as a backup.
• You’re only treating the symptom, not the underlying issue of unaffordable debt.
• If you default again, you’ve lost retirement money with nothing to show for it.

As you can see, raiding retirement funds now can leave you in worse shape later in life. It also doesn’t fix the root problem of having too much auto loan debt for your budget.

Alternatives to Consider First

Before tapping your retirement account to pay off a defaulted auto loan, explore all of your other options first. Here are some alternatives to consider:

• Contact your lender – They may offer hardship options or loan modifications.
• Refinance the loan – You may qualify for better terms with another lender.
• Sell the car – Swap it for a more affordable used car if needed.
• Defer payments – Ask for a temporary pause on payments if you have a short-term hardship.
• Use other savings – Tap your emergency fund instead of retirement savings.
• Get help from family – Borrow from relatives or friends before touching retirement funds.
• Pick up extra work – Some side hustle income can help catch up on payments.
• Cut expenses – Trim your budget so you can afford the payments.

Ideally, you’ll be able to find a solution that avoids raiding your retirement account. This protects your future while still helping you resolve the defaulted auto loan situation.

The Last Resort

If you’ve explored all other options and determined that tapping your retirement account is truly the only way to avoid repossession of your car, proceed with extreme caution. Here are some tips:

• Only withdraw the exact amount you need to catch up on payments and fees to cure the default.
• Have a repayment plan to replenish the borrowed retirement funds within a few years.
• Make sure you can afford the ongoing monthly auto loan payments so you don’t end up defaulting again.
• Consult a tax pro – You may owe penalties if you’re under age 59 1/2.
• Review the terms of your retirement account – Some plans don’t allow withdrawals.
• Consider a 401(k) loan instead of withdrawal if possible – You’ll repay yourself over time.

While far from ideal, tapping your retirement savings to get out of auto loan default can be the right move as a last resort. Just be sure to limit the damage as much as possible and have a plan to rebuild those savings.

The Bottom Line

Using retirement funds to pay off a defaulted car loan can throw you a lifeline, but also puts your future at risk. Before taking the plunge, be sure you’ve exhausted all other options and have a repayment plan for the borrowed money. With strategic planning, you can cure the default, keep your car, and still have a shot at retiring comfortably.