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A 401(k) loan allows you to access the money you’ve set aside for retirement in your 401(k) account. The interest payments you’ll make while paying back the loan will go into your 401(k) account. Typically, you have five years to pay back the loan.
However, a loan from your 401(k) may affect your overall retirement savings and could have unforeseen consequences, particularly if you change your employment. Here’s what to know.
- 401(k) loan rules
- Is it a good idea to borrow from your 401(k)?
- 401(k) loans: Pros and cons
- 401(k) loans vs. personal loans
- Other alternatives to a 401(k) loan
- Compare multiple options before borrowing
401(k) loan rules
Though the exact steps may vary by employer plan, here is generally how you’ll take out a loan from your 401(k):
- Determine how much you want to borrow. In most cases, you can’t borrow more than 50% of your vested account balance or $50,000, whichever is less. However, this 50% rule is waived for account holders with a vested account balance of $10,000 or less — in this case, you can borrow up to $10,000.
- Contact your 401(k) provider. Depending on your plan, you may be able to log into your account online and head to the relevant section where you can request a loan.
- Understand your repayment terms and interest rate. Before agreeing to the loan, check to see what interest rate you’ll receive and figure out if you’re able to pay back your loan within five years. Ask your 401(k) provider to show you what your payroll deductions will be to pay back your loan.
- Complete the application and wait for your loan funds. Fill out any required paperwork to finalize your loan. Then the funds should arrive with your next paycheck.
Is it a good idea to borrow from your 401(k)?
Borrowing from your 401(k) can make sense if you need emergency funding for expenses that can reasonably be repaid within five years.
However, consider alternatives if you’re looking to borrow any amount that isn’t absolutely essential. For instance, if you want to take a family vacation, a 401(k) loan is not a good source of funds. Budgeting and saving, or even a personal loan, would be a far better option.
You should also avoid a 401(k) loan if you don’t think you’ll be with your employer for the next five years, as we discuss in the pros and cons section below.
401(k) loans: Pros and cons
A loan from your 401(k) is frequently not the best choice, but may be your only choice in certain circumstances. Consider the benefits and drawbacks before you proceed:
- No credit check: Since you’re borrowing money from yourself, you won’t have to undergo a credit check to get a 401(k) loan.
- Lower interest rate: You might get a lower 401(k) loan interest rate compared to a personal loan. Plus, the interest you pay goes into your account.
- Accessible funding: Generally, you could receive funds within several days with a 401(k) loan.
- Flexible repayment options: Though most 401(k) loans require you to pay your loan back in five years, you can generally pay it back faster with no prepayment penalty. You can even choose to pay it back automatically using payroll deductions.
- No opportunity to build credit: A 401(k) loan isn’t reported to the credit bureaus, which means it doesn’t positively (or negatively) affect your credit.
- Loss of investment gains: The biggest issue with a 401(k) loan is that you’ll lose the opportunity for investment gains by taking money out of the account. Additionally, because 401(k) loans have low interest rates, the interest rate you pay may not make up for lost gains.
- Limited loan amounts: You can only borrow up to 50% of your vested balance or $50,000, whichever is less. This might not be enough to cover your expenses.
- Employment requirements: If you’re laid off or change jobs before paying off the loan, you may have to pay it back within a short period of time (determined by your plan’s sponsor) or face income taxes and a 10% early withdrawal penalty.
- Potential tax payment and penalty: If you can’t pay back your loan on time, the remaining balance will most likely be counted as a 401(k) withdrawal, and you’ll need to pay any applicable income taxes and penalties.
- Double taxes: When you repay the 401(k) loan, you do so with after-tax dollars. When you make 401(k) withdrawals down the line, perhaps in retirement, these funds will be taxed again.
- Could undermine retirement plans: While a 401(k) loan might be appealing, taking money out of an invested retirement account could significantly reduce your long-term retirement savings. Losing compound interest over five years can be a high cost that you might not be able to repay.
401(k) loans vs. personal loans
Getting a loan from your 401(k) isn’t the only way to access quick cash. You can also take out a personal loan for a wide range of expenses, even if you have bad credit. Personal loans can fund the same day you apply, in some cases, but usually fund within one week.
Here are some important points to keep in mind when comparing 401(k) loans vs. personal loans:
|APR||Generally 1.00% to 2.00% over the prime rate||Varies|
|Loan amount||50% of your vested balance or $50,000|
(whichever is less)
|$600 to $200,000
(with Credible partner lenders)
|Loan terms||Up to 5 years||1 to 12 years
(depending on the lender and loan purpose)
|Credit check required?||No||Typically yes|
|Minimum credit score||Credit score not required||Usually 620 or higher
(though some lenders accept lower scores)
|Fees||None (but liable for taxes and penalties if not paid back)||Origination and late fees (depending on lender)|
If you want to protect your retirement savings, a personal loan could be a better choice compared to a 401(k) loan. Before you borrow, be sure to consider various personal loan lenders to find the right loan for you.
|Lender||Fixed rates||Loan amounts||Min. credit score||Loan terms (years)|
|7.99% - 29.99% APR||$7,500 to $50,000||Not disclosed by lender||2, 3, 4, 5|
|9.95% - 35.99% APR||$2,000 to $35,000**||550||2, 3, 4, 5*|
|11.79% - 20.84% APR||$10,000 to $50,000||730||3, 4, 5, 6|
|8.99% - 35.99% APR||$5,000 to $35,000||600||2, 3, 4, 5|
|7.99% - 24.99% APR||$2,500 to $40,000||660||3, 4, 5, 6, 7|
|11.52% - 24.81% APR||$5,000 to $40,000||640||2, 3, 4, 5|
|9.57% - 35.99% APR||$1,000 to $40,000||660||3, 5|
|7.99% - 35.99% APR||$2,000 to $36,500||660||2, 3, 4, 5, 6|
|7.99% - 25.49% APR with autopay||$5,000 to $100,000||700||2, 3, 4, 5, 6, 7
(up to 12 years for home improvement loans)
|18.0% - 35.99% APR||$1,500 to $20,000||None||2, 3, 4, 5|
|8.49% - 17.99% APR||$600 to $50,000 |
(depending on loan term)
|700||1, 2, 3, 4, 5|
|8.99% - 25.81% APR10||$5,000 to $100,000||Does not disclose||2, 3, 4, 5, 6, 7|
|11.69% - 35.99% APR7||$1,000 to $50,000||560||3, 5, or 7 years 8|
|8.49% - 35.99% APR||$1,000 to $50,000||600||2, 3, 5, 6|
|5.2% - 35.99% APR4||$1,000 to $50,0005||620||3 or 5 years4|
401(k) loans vs. 401(k) withdrawals
Instead of a 401(k) loan, you could choose to make a 401(k) withdrawal instead. The main advantage of making a withdrawal is that you don’t have to worry about paying back a loan — useful if you don’t believe you’ll be able to pay it back within five years. Plus, if you’re 65 or retirement age (as defined by your plan), you shouldn’t have to pay a penalty on withdrawals.
However, in most cases, you’ll have to pay income tax on the amount you withdraw plus a 10% early withdrawal penalty if you’re under 65. A 401(k) loan, on the other hand, doesn’t make you pay taxes on the amount you take (unless you don’t pay it back on time).
Other alternatives to a 401(k) loan
Here are a few other 401(k) loan alternatives to consider:
- Credit card purchase: If the amount you need can be covered by credit, consider this option seriously, especially if you can pay the funds back within a short period of time and are eligible for a promotional APR.
- Credit card balance transfer: If your goal is to clear credit card balances, you may be able to transfer them onto a new or existing credit card, which could potentially reduce your overall interest rate.
- Home equity loan: If you’re a homeowner, you might be able to tap into its equity. Because your property acts as collateral for this type of loan, you might get a lower interest rate compared to a personal loan. But keep in mind that if you default on the loan, you risk losing your home.
- Home equity line of credit (HELOC): This is another way to access your home’s equity. But unlike a home equity loan, a HELOC is a type of revolving credit that you can access as you need and pay back only what you use. Just remember that if you can’t keep up with your payments, you could lose your home.
- Roth IRA: You can always make penalty- and tax-free withdrawals from your Roth up to the amount of your contributions.
- HSA: If you need funds for a qualified medical expense, you can use your health savings account tax-free. For nonqualified expenses, you may be taxed on the amount withdrawn, plus a penalty.
- Brokerage account: The money in this type of investment account is yours to do with as you wish. Making withdrawals means you’re using your own money, and they’re tax-free.
- Savings and checking accounts: If you only need a smaller amount of money, and you have emergency funds, tap into those instead. Then you can work toward replenishing the account.
Compare multiple options before borrowing from retirement savings
Taking a loan from your 401(k) is essentially borrowing from your future self. Even if you pay off your 401(k) loan without issue, you could end up with less money during retirement due to the loss of compounding interest over the five years it takes you to repay the loan.
This reduction in retirement savings could become even worse if you lose a job before fully paying off the loan or fail to continue making loan payments.
This is why it’s important to compare all of your loan options before deciding to borrow from your retirement savings. Though the interest rate and fees might seem initially higher on a personal loan or other alternative, the cost to your future could be much lower.
If you decide to take out a personal loan, remember to consider multiple lenders to find a loan that suits your needs.
Emily Guy Birken has contributed to the reporting of this article.