401(k) Loans vs. Personal Loans: Which Is Right for You?

Each has pros and cons depending on your situation

401(k) Loans vs. Personal Loans: An Overview

A 401(k) loan and a personal loan are two options if you need to borrow money. A 401(k) loan involves borrowing from your retirement account. A personal loan involves borrowing from a lender, such as a bank, credit union, or online lender. Both options have pros and cons. Here’s how to decide which one (if either) is right for you.

Key Takeaways

You might be able to borrow money from your 401(k), depending on your plan's rules. You will need to repay the amount you borrow plus interest.
A 401(k) loan can be a fast way to obtain funds, but there are potential tax consequences to consider.
You can obtain a personal loan from a bank, credit union, or online lender. You will repay the amount you borrow in installments plus interest.
Personal loans can also be a quick way to obtain cash, but it is important to compare interest rates and fees.

401(k) Loans

A 401(k) loan can allow you to access a portion of the money in your retirement account, if your employer allows it.

Typically, you can use a 401(k) loan for whatever you want to, although some plans may set limitations.

Under Internal Revenue Service rules, you can borrow up to 50% of your vested account balance or $50,000, whichever is less. In some cases, if 50% of your vested balance is less than $10,000 you may be able to borrow up to $10,000.

Like any other type of loan, a 401(k) loan must be repaid with interest. Your plan administrator will determine the interest rate and the repayment term.

In most cases, you will have five years to repay a 401(k) loan and be required to make payments at least quarterly. If you use the loan to purchase a home as your primary residence, you will have a longer repayment period. This period will be determined by your plan administrator.

Some employers also offer alternatives to 401(k) loans so their employees can avoid tapping their retirement savings.

Pros and Cons of 401(k) Loans

The potential pros of a 401(k) loan include:

Convenience. Obtaining a 401(k) loan does not require a lengthy application process or credit check. Usually, you can receive the funds within a few days.
Low cost. A 401(k) loan is less expensive than many other types of loans. It may involve a small origination fee, but your repayments, including any interest, will go back into your account.
Flexible repayment. In most cases, you will have five years to repay a 401(k) loan. If you wish, you can repay the loan early without incurring a prepayment penalty. You can also arrange to make your payments via automatic payroll deductions.

The potential cons of a 401(k) loan include:

Might have to repay quickly. If you lose your job or quit with an outstanding loan balance, you will have to repay the loan in full on a relatively short timeline.
Taxes. If you do not repay your loan, the outstanding balance will be treated as a distribution. This means will you will have to pay income taxes on the money and if you are under the age of 59½ you will also owe a 10% early-withdrawal penalty.

Personal Loans

Personal loans give borrowers access to a lump sum of cash that must be paid back in fixed, monthly installments, with interest. This type of loan is usually unsecured, which means borrowers do not have to provide collateral.

Personal loans can be used for many different purposes, such as a wedding, medical bills, and home repairs. However, most lenders will not allow you to use one for college tuition. (Of course, there are other loans available for that purpose, such as federal student loans.)

The amount of money you can borrow with a personal loan will depend on the lender and your creditworthiness. The maximum amount is typically $100,000.

The costs of a personal loan can vary widely from one lender to another, so it’s important to shop around and compare interest rates, fees, and repayment terms.

Pros and Cons of Personal Loans

The potential benefits of a personal loan include:

High borrowing limits. Depending on your creditworthiness, you may be able to borrow a significant lump sum.
Predictable repayment schedule. Fixed monthly payments can make it easy to budget.
No collateral. You usually do not need to provide collateral to secure a personal loan.

The potential downsides of a personal loan include:

Possibly strict credit requirements. Lenders will run a credit check to assess your creditworthiness before offering you a personal loan. A low credit score may make it impossible to obtain a personal loan at a reasonable rate, or at all.
Higher interest rates than some loans. The interest rate on a personal loan can be higher than that on a secured loan, such as a home mortgage.
Fees. In addition to interest, lenders may charge fees on personal loans.

401(k) Loans vs. Personal Loans at a Glance

	401(k) Loans	Personal Loans
Maximum loan amount	$50,000, or 50% of your account balance, whichever is less	$100,000, but varies depending on the lender and your creditworthiness
Interest rate	Varies	Varies
Repayment term	Five years, in most cases	Varies
Credit impact	None	Potentially positive with on-time payments, negative with late payments or default

401(k) Loan vs. Personal Loan: Which One Should You Use?

If you are deciding between a 401(k) loan or a personal loan, you'll want to consider:

The amount you need to borrow. If you need to borrow more than $50,000 or half of your 401(k) account balance, a personal loan could be your only option.
Interest rates and fees. A personal loan may come with a higher interest rate and more fees than a 401(k) loan.
Repayment terms. You may have more time to repay a personal loan than a 401(k) loan. Keep in mind, however, that a longer repayment period means paying more in interest overall.
Your credit history. If you have a poor credit history, it may be difficult to obtain a personal loan with favorable terms. Your credit history does not affect your ability to obtain a 401(k) loan.
Your job stability. Your employment situation can impact your ability to repay any kind of loan. But if you have a 401(k) loan and lose your job, you will likely need to repay the loan quickly or owe taxes on the amount you borrowed.

Does a 401(k) Loan Count as Debt?

A 401(k) loan is not considered debt because you are borrowing from your own retirement funds. So it will not affect your credit score or debt-to-income (DTI) ratio.

Can You Repay a 401(k) Loan in a Lump Sum?

You can pay back a 401(k) loan early and in full if you decide to. In most cases, there is no prepayment penalty.

What Is the 12-Month Rule for 401(k) Loans?

If you want to take out more than one 401(k) loan in a 12-month period, the amount you borrow plus your outstanding balance cannot exceed $50,000 or 50% of the total amount in your 401(k).

Is It Better to Take a 401(k) Loan or a Withdrawal From Your 401(k)?

A 401(k) loan means temporarily borrowing money from your retirement account. You will have to pay yourself back over time.

A 401(k) withdrawal, on the other hand, permanently removes money from your account. While you don't have to pay the money back, you may be subject to income taxes and a 10% early withdrawal penalty if you are under age 59½. In addition, you will have that much less money saved for retirement when the day comes.

How Much Does Your Credit Score Drop When You Get a Personal Loan?

A lender will likely conduct a hard inquiry before offering you a personal loan. This involves obtaining your full credit report and may result in a small dip in your credit score.

However, as you make on-time payments, a personal loan can help boost your credit score.

The Bottom Line

A 401(k) loan and a personal loan are two options if you need to borrow money, and both come with pros and cons. It's worth taking the time to consider how much you need to borrow, what that will cost, and how likely you are to be able to repay before applying for any type of loan.