Getting Help Springing the Debt Trap

Question of the week:We've really gotten in over our heads with our credit cards over the last couple of years, and are starting to consider going to a consumer credit counseling agency for help. Do you think this is a smart move? --A.T., Wisconsin

Dear A.T.,

According to the Consumer Federation of America, approximately nine million Americans have some contact with a consumer credit counseling agency each year. When we asked members of the Armchair Millionaire community about their experiences going to an agency for help, we generally heard positive responses. Here are two:

A lifesaver. "I got left with $10,000 debt after a divorce. Consumer credit counseling was a lifesaver! Half my debt was interest free for the four years it took for me to pay it off and the other was dropped to 8 percent. Afterwards, when applying for a mortgage, it came up, but when I explained it they had no problem." --Meg H.

Do it yourself and save the fee. "I'm in the midst of paying down significant debt right now. I've used a consumer credit counseling agency and it worked out fine, but then I realized I could do it myself and save the fee the agency was charging me. Every little bit helps when trying to pay off debt." --Jenny

A good credit counseling company will work with you to create a debt management plan and with your creditors to create repayment plans and in some cases, to lower their interest rates. They should also provide financial education to help you improve your overall financial picture and help you to not get back into debt again.

But you should be aware that the credit counseling industry has come under fire recently from the IRS, the Federal Trade Commission and other groups for allegations of excessive fees and deceptive marketing. This doesn't necessarily mean that you shouldn't seek help from a credit agency, because there are hundreds of reputable agencies who have helped thousands of people.

What it does mean, however, is that you need to check into an agency very carefully before choosing to work with it. My guide tells what to look for.

The Armchair Millionaire's Guide to Consumer Credit Counseling

• Fees. Fees vary from agency to agency, and you should look for a good deal. According to the Consumer Federation of America, you should avoid fees higher than $50 to set up a debt management plan and monthly fees higher than $25. And the agency should be upfront about their fees, providing you specific prices in writing.
• Services. Does it offer more than just help creating a debt management plan? You may also want budget counseling want debt counseling and other financial education. You may also want the option to work with a counselor not just in person, but also on the phone or over the Internet.
• Your best interest. Credit counseling agencies are supposed to operate with your best interest in mind, but not all do. Look out for agencies where employees are paid by commission, or that doesn't spend enough time with you to formulate a solution that will work for you. And don't assume that just because an agency has non-profit status that it's automatically looking out for your best interest.
• Advertising. Be wary of agencies that advertise aggressively through telemarketing or that make unreasonable promises to "repair" your credit. While the best way to find a good agency is generally through referrals from friends or family members, you should also check out any agency you're considering with your state attorney general's office or Better Business Bureau to find out if any consumer complaints have been filed against it.

THE BOTTOM LINE: It's not easy to ask for help when you have more debt than you can handle. But it can be the way out of the debt trap--provided you ask for help from the right credit counseling agency.

Debt: How Much Is Too Much?

Question of the week:We're considering remodeling part of our house, but it will mean taking on a sizable home equity loan, which we're not entirely comfortable with. Is there a good way to know when you're taking on too much debt? --L.K., Chicago Dear L.K., You're wise to be wary of taking on new debt. Too often I see people simply borrow as much as lenders will possibly let them without ever stopping to consider if that amount of debt is actually right for them. Your question has many sides to it, and there's no single right answer for everyone. For some perspective, we recently asked members of the Armchair Millionaire community about how much debt they're willing to take on. This comment from Mattchiavo shows how he comes up with his own answers: Balance is everything. "I think one needs a balance. Most people will not be able to buy a home without borrowing, so you should borrow but stay at a reasonable level. Personally I like to keep my mortgage payments between 10 and 12 percent of my gross monthly pay. Do I have the biggest and nicest house? Nope, but I have a comfortable house with a comfortable mortgage. I also like to keep my car payments to 3 to 5 percent of my gross pay. Do I have the biggest and nicest car? Nope, but I have a comfortable car with comfortable payments." Mattchiavo is on the right track. I generally recommend that people try to spend a maximum of 20 percent of their gross pay on large-scale debts related to their home in order to remain well within a common sense financial plan. However, you still need to consider the whole picture because the kinds of expenses each of us has varies so much from person to person. When considering taking on substantial new debt, there are a few different figures that you should review to see if your personal financial profile still falls within your personal comfort zone. These are the same figures that lenders (banks, credit cards, etc.) will consider when they make a lending decision. The Armchair Millionaire Guide to Creating Your Debt-Worthiness Profile Ability to repay. Do you earn enough to make the payments? Do you have so much other debt that it would affect your ability to repay the new debt? Lenders often calculate your debt-to-income ratio to guide them here. This is the total amount of your monthly debt payments, including the new expected debt payment, divided by your gross monthly income. Collateral. Is the value of your collateral (usually a home or car) enough to ensure that the lender will recoup its losses, should you fail to pay? To help them here, lenders will often use the loan-to-value ratio--the amount borrowed divided by the value of the collateral. Credit history. When preparing to take on new debt, you should also review your credit history with the three large credit reporting agencies (TransUnion, Equifax and Experian) and close any old accounts or correct mistakes. If you've had any bankruptcies or foreclosures, this will be a significant strike against you. Cash on hand. How much cash will you have left over after any down payment and/or loan closing costs? Do you have just enough? Or more than enough? Purpose. Lenders also look at how you'll use the money. They might consider a loan to buy an apartment building (where you will depend on rents from tenants to be able to make your payments) riskier than a home mortgage loan, for example. THE BOTTOM LINE: Lenders follow basic rules of thumb. You should have your own rules of thumb that balance your financial profile with your personal level of comfort. Strike a good balance between the two and you'll generally choose the smartest path.

Trimming Your Student Loan Payments to Size

Question of the week:With the lower interest rates, it seems everyone's been refinancing their mortgages. Is there anyway to re-negotiate my student loans? And if so, should I? --Alison S.

Dear Alison,

Your timing is excellent, given that the interest rates on Stafford federal student loans dispersed since 1998 dropped to an all-time low this summer--3.42 percent. (Compared to what rates have been in recent years, this is an incredible bargain--as recently as 2001, the rate was 8.19 percent on these loans.) That means that rates for consolidation loans will be lower, too.

We asked the Armchair Millionaire community to tell us about their experiences with student loan consolidating, and heard many stories. Here are two:

Happy to have consolidated. "I have about $16,000 in student loans and am perfectly happy with that. I have since consolidated my loans and locked in a low interest rate. Student loans are good debt, and worth the investment." --Travis

Consolidated too soon. "I consolidated once soon after graduation because I liked the idea of a fixed rate. I wish I hadn't done that, now that the rates have gone down so much, and I can't find a way to refinance that lowers the rates. I don't regret taking student loans to pay for college, but I do regret the way I managed them in the early years." --Robin

People consolidate their student loans for the same reason they usually refinance their mortgages: to reduce their monthly payments. When you consolidate, your original loans are paid off in full in return for a single loan for the combined balances. The new loan will typically have a lower interest rate that is fixed for the life of the loan. If this sounds appealing to you, my guide will provide you with the basic information you need to get started.

The Armchair Millionaire Guide to Student Loan Consolidation

• Is consolidating right for me? If the consolidation loan offers you a lower rate than you're paying now, it probably is, particularly if you're having trouble making your monthly payments. If you're close to paying off your student loans, however, it may not be worth the trouble.
• What interest rate will I pay? It depends on the rates you're currently paying on your loans. The interest rate for consolidation loans is calculated by taking the weighted interest rate of all the loans being consolidated and rounding up to the nearest one-eighth of one percent, with a cap of 8.25 percent. There's an online calculator that will do the math for you on the U.S. Department of Education's loan consolidation Web site at www.loanconsolidation.ed.gov.
• How much will I save? According to Sallie Mae, the leading provider of student loans in the U.S., consolidating student loans could reduce your monthly payments by up to 54 percent. However, these kinds of savings are achieved in part by extending your repayment term. (Depending on the amount you're consolidating, this could be all the way up to 30 years.) If you choose to extend your repayment term, it will take longer to pay off your overall debt and you're total interest expense will be higher.
• Any other advantages? Many lenders will reduce your interest rate by one percent after you've had an on-time payment record for a certain period, such as 36 or 48 months. You can also receive a quarter-point reduction in your interest rate by agreeing to pay by automatic debit. Also, there are no pre-payment penalties on consolidation loans.
• Where do I get a consolidation loan? From any bank or credit union participating in the Federal Family Education Loan Program, or directly from the U.S. Department of Education. The loan terms and conditions are generally the same, regardless of where you consolidate.

THE BOTTOM LINE: Once you consolidate your student loans, they're gone and there's no going back. Since you can only consolidate once, be sure that it's the best financial move that you can make before plunging ahead.

The Co-Signing Conundrum

Question of the week:Our son is fresh out of college, has just started working, and needs a car. He's asked us to co-sign a car loan for him. While we really want to help out, we've heard some horror stories about co-signing loans. What would you do in our shoes? --Milwaukee Dad

Dear Milwaukee,

Like most issues having to do with money and families, co-signing a loan for a relative presents a lot of sticky issues. To get some perspective, we recently asked members of the Armchair Millionaire community about their experiences as co-signers. We heard both the good and the bad:

"I co-signed a loan for my brother on a motorcycle with the understanding that if he didn't make the payment I got the bike. It worked out just fine. He made all the payments and now has the start of a good credit history." --David

"I co-signed for an apartment for my son. When he stopped paying the rent the landlord didn't even bother to let me know, just filed suit and piled on a bunch of phony fees, knowing that I was good for it. Creeps!" --Merle S.

The most important thing to know about co-signing is that it's really no different than getting your own loan. You will be just as responsible for paying off the loan as the primary borrower. That means if your son doesn't pay, the lender will expect you to make the payments. The loan will also become part of your credit history.

To make a good decision, you really need to separate emotions from facts. My guide will help.

The Armchair Millionaire Guide to the Co-Signing Decision

• Consider why the borrower wants you to co-sign the loan. Chances are it's because they've been turned down by a commercial lender, meaning they're probably not a great credit risk. This means you shouldn't co-sign unless you are willing (and able) to take over all the payments yourself.
• Look at the borrower realistically. Do they have a job that pays enough to enable them to make the loan payments? Have they been responsible with money in the past? Have they paid you back when you've loaned them money in the past? If they have a poor track record of managing their money, co-signing a loan for them isn't going to change that.
• Understand how it may reduce your ability to borrow. Since a cosigned loan is your responsibility, banks and mortgage companies will include the loan amount as part of your overall debt when considering making a loan to you. If you plan on taking out a loan yourself anytime soon, take this into account.
• Be aware of the worst-case scenario. If the primary borrower doesn't pay, you'll have to. You'll also be liable for late fees and collection costs. If you put up your own property to secure the loan and the borrow defaults, you could lose that property. And in some states, the lender can try to collect the debt from you before it even tries to collect from the primary borrower.
• Balance out the negative with the positive. All is not bad with co-signing. It allows you to help out your child by giving them a chance to establish their own credit history, making it easier for them to get a loan the next time. But such upsides should be seriously weighed against the many pitfalls.

THE BOTTOM LINE: Even though you may be willing to take full responsibility for the loan, doing so may put serious strain on your relationship with the primary borrower. At the end of the day, money is always less important than the relationships in your life. If in doubt, err on the side of keeping those relationships.

Slaying the Plastic Monster

Question of the week:I've really gotten in over my head with credit card debt, and it is beginning to seriously worry me. What's your strategy for paying off credit card debt once and for all? --E.D.

Dear E.D.,

While it can be discouraging to face a mountain of credit card debt, it's important to remember that there is a way out. We heard many success stories when we asked members of the Armchair Millionaire community about their experiences in cutting their debt down to size. This one is typical:

"My wife and I got ourselves into a substantial amount of credit card debt over the past five years. It all started back in college, but snowballed out of control when we got married, went on a honeymoon and a cruise and bought a house. We learned our lesson and now have just one credit card for emergencies. So far, we have not touched a credit card in six months and are on our way to being debt free." --N.W.

The key is to systematically confront your credit card debt with sound tactics designed to accelerate your repayments and reduce the overall interest you pay. My checklist has the essential moves.

The Armchair Millionaire Checklist for Digging Out of Credit Card Debt

• Stop charging! If you can't afford to buy something without using a credit card, do without. While this may feel a bit painful at first, many people find that the things they've been buying with credit are things they really don't need.
• Double (or triple or quadruple) your payments on the credit card with the highest interest. This card is costing you the most, so concentrate on paying it off first. Once it's taken care of, move on to the card with the next-highest interest.
• Use your "extra" money. Whenever you receive "extra" income--like a tax refund, gift, or raise--commit it to credit card repayment. Since you hadn't planned on this income, you won't miss it, and those extra payments can make a big difference.
• Dig into savings. If you have some money stashed away in a low interest account (like a savings account), think about using it to pay down some debt. Your savings account is only paying you one or two percent interest, but you're paying much more than that on your debt.
• Consider finding an extra source of income. A second job doesn't have to be a huge time burden--even a few hours each weekend will earn you a nice chunk of money each month that will go a long way towards speeding up your debt repayment.
• Keep going. By the time you've paid off your credit card debt, you'll have developed a great set of money management skills. Put them to work on an investing program that will put your money to work to fund your long-term dreams.

THE BOTTOM LINE: Besides making you feel awful, debt is your main barrier to building a financially secure future. But by using some common sense techniques, you can push that monkey off your back.

Getting the Proper Credit

Question of the week:My brother-in-law orders a copy of his credit report every single year, but I've never even seen mine. Does it really matter all that much? --Dianne T.

Dear Dianne,

It's a good idea to periodically check on the accuracy of your credit reports. This is especially important if you're considering a major purchase, like a home or a car. Checking in advance on the accuracy of your information could speed the credit-granting process.

When we asked members of the Armchair Millionaire community about checking their reports, we heard a range of good reasons for checking your credit. Here are some examples:

"I check mine every two years and look for obvious errors. This is also a good time to close those accounts that are still open that you do not use anymore." --Paul K.

"We routinely find minimal mistakes on our credit reports, like wrong addresses or incorrect employers. We've even found incorrect account information or loans which were still being reported as open, even though they were actually paid in full and closed." --Jennifer G.

"I was a victim of credit fraud years ago. I have checked my report from all three bureaus on a regular basis ever since." --Jose R.

Since you've never obtained your credit report before, my guide provides you the basics on how to get it and what you'll find on it.

The Armchair Millionaire Guide to Credit Reports

• Getting your report. You can order a copy of your report through the Web sites of each of the three major credit reporting agencies:
  • Equifax (www.equifax.com)
  • Experian (www.experian.com)
  • TransUnion (www.transunion.com)
  Since more than one agency may have a file on you, with different information, you may want to contact each one. In most cases, you'll pay $9.00 per report, although depending on situation, the report may cost slightly less, or even be free

• What's on your report. There are four kinds of information:
  • Identifying information. This means your name, current and previous addresses, Social Security number, year of birth, employment history and income, and home ownership.
  • Credit information. This is your record of paying back loans and credit cards. It includes the date you opened each account, your credit limit or loan amount, balance, monthly payments and payment record over the past several years. If you've had an overdue account referred to a collection agency, that would be included here, as well.
  • Public record information. This includes bankruptcies, tax liens judgments, and any other information available from public records.
  • Inquiries. These are the names of those who have requested a copy of your credit report.

• Where the information comes from. It comes from a wide variety of sources: banks, credit card companies, mortgage and finance companies, credit unions, commercial lenders, and department stores, local merchants, landlords, insurance companies, utilities, hospitals, doctors, lawyers and other professionals. It is also gathered from the public records of municipal, state and federal agencies, land record offices and other government agencies.

• Who gets to see it. The Fair Credit Reporting Act sets the rules about who has access to your report. It's generally limited to people you have initiated business with, such as landlords, lenders and credit card companies, who have a "permissible reason" to see your report. Employers and prospective employers can also see it, provided you've given them written permission to do so.

THE BOTTOM LINE: Because your credit file changes constantly, it's important to review it from time to time to check that it's correct. This is a basic financial housekeeping chore that everyone should take care of on a regular basis.

Should You Be the Family Banker?

Question of the week:Our daughter has approached us about the possibility of borrowing $12,000 for a down payment on her first home. She's always been responsible with money, but we're still hesitant. What do you think about making loans to family? --G.L.

Dear G.L.,

You've hit upon an emotional topic that brings up strong opinions. We recently asked the Armchair Millionaire community about their experience with making loans to family members, and heard both the good and bad:

"I've loaned money to my parents and siblings and have borrowed from them as well over time. We have always treated these loans as serious financial obligations and have always paid interest at fair market rates, with no problems." --Ted C.

"In past years, I lent thousands of dollars to cash-strapped relatives and never was paid back one dime. Therefore, I have made it a strict policy to never lend money to relatives again." --Wendi H.

Most of us truly want to be able to help family members, but before you jump in, consider the consequences as rationally as possible. Ask yourself:

• Is the would-be borrower a good credit risk? Has he or she paid off debts on time in the past, or had a hard time keeping financial promises?
• Will the loan be used for something that will appreciate (such as a house) or return a value (such as a grad school education)? Or will it be used to pay off other debt or simply for living expenses?
• Can you afford it? If the only way you can lend money is to borrow it yourself--such as from a home equity loan or from your credit cards--then you can't afford to make the loan. I suggest that you lend the money only if you can afford to never see a single repayment.

If you're inclined to make the loan, go about it in a businesslike way. My checklist will help improve your odds for a positive outcome.

The Armchair Millionaire Checklist for Lending Money to Family Members

Treat it as a business transaction. Put everything in writing, including the loan amount, interest rate and payment schedule.

• Set a reasonable interest rate. You might set an interest rate somewhere between what you would receive if you kept the money in a money market account and the rate the borrower would have to pay if they were to borrow from a bank. In this way, you would both come out ahead. Keep in mind, however, that depending on the size of the loan, you may need to charge the applicable federal interest rate, which is set by the IRS.
• Decide in advance what to do about non-payment. You might charge a late fee, or require a token monthly payment as proof of continuing good faith. You might allow an occasional "grace period" where interest still accrues. Spell it out in your agreement and make sure the borrower understands what will happen if they miss payments.
• Get help from a professional. Depending on the nature of the loan, it could carry significant legal, tax and estate planning implications. I strongly recommend seeking the advice of an attorney or CPA before finalizing the loan.
• Keep everything in perspective. Remember that in the long run, your relationship is more important than the money. If the loan goes south, you may decide to cut your losses in order to preserve the relationship.

THE BOTTOM LINE: Mixing money and families is never easy, so weigh the situation carefully before shelling out your cash for a loan. If you decide to lend the money, go about it in a way that will keep you and the borrower on good terms.

Borrowing from Yourself

Question of the week:Money is tight and I'm thinking about taking out a loan from my 401(k). Borrowing from myself--and paying the interest to myself--seems like a no-brainer. What do you think? --2LT

Dear 2LT,

You're not alone in considering this. According to Hewitt Associates, a major HR consulting firm, 94 percent of all 401(k) plans are set up to allow loans. And plenty of people take advantage of them-nearly one out of every five people with a 401(k) has a loan outstanding.

When we asked members of the Armchair Millionaire community about the wisdom of borrowing from a 401(k), we got mixed reviews:

"We did it at a good time when interest rates were very low, so we were actually making money when we paid ourselves back. However, the headache and frustration of knowing the money has to get back in there really wasn't worth it." --Bobbi T.

"No how, no way! Keep your mitts off your 401(k) unless in dire emergency. That's sacred money for old age!" --Betty

My opinion is that, in most cases, you should stay away from borrowing from your 401(k). While you're right that the interest payments you make go right back to yourself, it's important to consider the drawbacks:

• If you quit or are fired, you'll have to pay the loan back in full immediately--usually not a great situation when you've just left a job.
• You make your loan payments with after-tax money, but when you take distributions from your 401(k) upon retirement, you'll still owe tax on all that money. This means you'll end up paying taxes twice on the money used to pay back your loan.
• You miss out on the growth of your investment. Compounding returns are the magic ingredient for building your retirement fund, and you lose them when you take your money out for the loan. Depending on how much you borrow, you could end up with a significantly smaller nest egg.

I suggest you only borrow from your 401(k) if you absolutely must. For example, if you have an emergency on your hands and no other available funds. My guide provides the essentials of what you'll need to know.

The Armchair Millionaire Guide to Borrowing From Your 401(k)

• Interest. Rates are usually competitive with other kinds of loans-a point or two above the prime lending rate. Your principal and interest payments will be automatically deducted from your paycheck and put into your 401(k) account. The interest is not tax deductible.

• Loan amount. You can usually borrow up to $50,000 or one-half of your contributions and vested employer contributions, whichever is less.

• Repayment. You typically have to repay the loan within five years, although your plan might allow a longer term if you're using the money to buy a home.

• Defaulting. It's going to hurt if you fail to repay your loan. The unpaid balance will be treated like a distribution from your plan, meaning you'll have to pay income taxes on the amount and, in most cases, a ten percent early withdrawal penalty.

THE BOTTOM LINE: Borrowing from your 401(k) is not a brilliant financial move, but it could save your hide if you have no other alternatives. If you do borrow, know the rules, pay it back as soon as you can and, if possible, keep contributing to your plan.

Keeping Your Kid on the Right Credit Card Track

Question of the week:My son started college this fall and was immediately inundated with credit card offers. How can I make sure he doesn't get in over his head? --Cliff C.

Dear Cliff,

Your son is part of an overwhelming trend on college campuses these days. According to a survey done this year by Nellie Mae, a national student loan provider, 83 percent of all undergraduates now have at least one card. Nearly half (47 percent) have four or more cards, and the average credit debt per student is just over $2,300. It's clear that the credit card companies have been very successful in their attempts to snag young customers.

Most parents aren't going to have much success in preventing the onslaught of credit card offers. Instead, the best strategy is to focus on helping you son use credit wisely. We recently asked parents in the Armchair Millionaire community for their advice on this issue. Here's some of what we heard:

"I obtained a credit card with a $500 limit for my high school daughter. I explained how credit works, how easy it is to overspend and the importance of good credit. She has handled her card very well, is now in college and still keeps her balance, if any, very low. Since she has been responsible the credit card company has since raised her limit, but she has not raised her spending." --Cathy

"I gave my son a $500 card. If he spends sensibly (essential or emergency purchases only), and deposits the balance owed each month into a savings account, I refill his card. If I see pizza or computer games, and no effort to save, then I only pay the minimum. In the last year I have only had to make two minimum payments, and currently his balance is zero. He has saved about $250 a month, which will hopefully knock a big dent in his student loan by the time he graduates." --Andrew B.

Credit cards for college students are a double-edged sword. Used properly, they can help a student build a good credit record by the time they graduate, as well as providing security for emergencies. Used improperly, they will land students in a pile of debt (along with a bad credit rating) right when they are starting out and can least afford it. My checklist will help you help your kids to be smart credit users.

The Armchair Millionaire Checklist for Steering Your Kids Clear of Credit Card Trouble

• Stick with one card. Students simply don't need a fistful of cards. A single, low-rate, low-limit card will give them all the benefits of credit and help them stay away from the pitfalls of multiple cards.

• Help them ask the right questions. Encourage them to pause before plunking down their plastic and ask themselves some important questions: Do I really need this item? Is this purchase so urgent that I can't wait to buy it? Will I be able to pay off my balance this month? If not, considering what I'll pay in interest charges, is this purchase still worth it?

• Walk your talk. All the lectures in the world will do little good if you do not use credit responsibly yourself. If wise spending and judicious use of credit are important to you, the chances are excellent that they will be to your children, too.

• Consider stored value cards. These are not credit cards, but can be very useful in teaching responsible credit use. They allow parents to add money to their child's card by making a transfer from their bank account, and then to review the purchases online. The Visa Buxx card is one example of these prepaid cards.

THE BOTTOM LINE: Spending decisions, especially if they involve the use of credit cards, can have far more impact over a lifetime than investing decisions. Credit cards are a fact of life, so help your kids get into the right credit card and spending habits as early as possible.

Hands Off That 401(k) Cash

Question of the week:I'm 28 years old and have about $18,000 in my 401(k). I'm leaving my job for a new one next month and I'm thinking of cashing out my 401(k) to pay some bills and old college debts. What do you think? --Milwaukee Job Hopper Dear Job Hopper, You're certainly not alone in your temptation to use that money for something other than retirement. According to a study by global management consulting firm Hewitt Associates, 68 percent of 401(k) plan participants choose to take their money as a lump sum when changing jobs. But just because so many people do it certainly doesn't make it a good idea. I strongly urge you to think twice and carefully consider just exactly what the real cost of cashing out your 401(k) will be. Let's look at that $18,000. First, you'll have to pay a ten percent early withdrawal penalty to the IRS, along with regular income taxes on the money. Assuming that you pay 27 percent federal tax and five percent state tax, you'll wind up with just $10,440 after you pay the penalty and tax. Next, assume that you were to leave that $18,000 alone to continue its tax-deferred growth until you reach age 60-another 32 years. At an average annual return of 10 percent, it would grow to over $380,000. So cashing out that 401(k) really leaves you with just over half of what you had in your account and ultimately, $380,000 less for retirement. If the math alone doesn't convince you, take a look at some of the real-world experience of members of the Armchair Millionaire community who cashed out 401(k)s: "I cashed out and it was the worst financial mistake of my life. I used it to pay off credit cards, but it wasn't worth it. If I'd had a better understanding of the penalty and taxes that I ended up paying, I'd never have done it." --Suze G.T. "I had been laid off from my first real job and money was tight. I cashed it out, paid the tax and used the money for a down payment on my first home. Who knows what it would be worth now if I had only rolled it over …" --D. My checklist will give you the details on alternatives to cashing out that 401(k). The Armchair Millionaire's Checklist of 401(k) Choices for Job Changers Roll it over into a traditional IRA. This means simply moving your money from your 401(k) to an IRA. Any mutual fund company or brokerage will be able to supply you with information for setting up a rollover IRA and making the transfer. (By the way, be sure to do a direct rollover, where the money is sent directly from your 401(k) to your IRA. If you take the cash and then deposit it yourself into the IRA, you'll be subject to a 20 percent backup withholding tax.) Keep it with your old employer. As long as you have at least $5,000 in your account, you can leave it in your former employer's plan. You might opt to do this if you especially like the investment choices it offers or if you just need more time to decide what to do. If you have between $1,000 and $5,000 in the account, however, your employer may choose to roll it over to an IRA on your behalf. Roll it over to your new employer's 401(k) plan. Most plans allow you to do this. Your human resources department will be able to give you information on eligibility and the forms you need to arrange the rollover. THE BOTTOM LINE: If you're changing jobs and faced with the decision of what to do with the money in your 401(k), think carefully. It might be tempting to walk away with a handful of cash, but it will end up costing far more than you may think.