I have a borrower who made mistakes with his finances. He fell for one of these scams advertising 'debt solutions.' The idea was that a person could stop paying their creditors and instead pay these solution providers. Loans would go into default (they don't mention that, by the way). Then this so-called debt solution company would negotiate a settlement of 30 cents on the dollar with the original creditor. At least, that was the plan.

For some deeply in debt, the idea of paying it off with just a third of the money owed is quite attractive. It is such an attractive thought to some that logic is tossed out of the equation. Needless to say, the company went out of business, liquidated its assets, and is now long gone. My client couldn't even sue to recover any money he had paid this company. Now he has $25,000 bad debt keeping him from being able to qualify for a home loan. The only way I can help him obtain a loan is for him to pay off the bad debt. He has $12,000 in a 401k from a past employer. Using the money to help pay off the debt will allow him to eliminate his debt and therefore buy a home.

Should he touch his hard earned retirement savings? Some people would say not to. I believe his savings is an illusion. One has to look at his net assets, which right now is near zero because of the debt. Interest and penalties will continue to accrue on the bad debt at a rate much higher that his 401k is earning, too. So the longer he waits, the deeper a hole he will dig for himself.

That, and his credit scores will permanently be affected by the bad debt unless they are paid. What would you do?