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401(k) Loans vs Personal Loans

401(k) Loans vs Personal Loans
Sulaiman Abdur-Rahman
Sulaiman Abdur-RahmanUpdated February 11, 2022
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Borrowing cash from a 401(k) retirement plan can serve as an alternative to taking out personal loans. A 401(k) loan can provide borrowers with a lump sum of money similar to a personal loan, and borrowers may use their 401(k) loan to pay for planned or unplanned expenses.A maximum 401(k) loan of $50,000 does not require borrowers to have good credit scores, whereas borrowers with excellent credit may qualify for personal loans up to $100,000. Personal loans and 401(k) loans each have their advantages and disadvantages. Below we provide more information about 401(k) loans vs personal loans and highlight their individual pros and cons.

What Is a Personal Loan?

A personal loan is an installment loan that provides borrowers with a lump sum of money. Borrowers may spend the funds on almost any personal endeavor, including debt consolidation, financing large purchases, or covering unplanned expenses. Borrowers are expected to repay the loan over a fixed term, including the principal amount and any interest charges owed.Lenders may review a borrower’s credit history and debt-to-income ratio when deciding whether to approve a borrower’s personal loan request. Banks, credit unions, and nonbank financial institutions may offer personal loans to consumers.

What Is a 401(k) Loan?

A 401(k) loan is a financial lending product that comes from an employee’s 401(k) retirement plan. Workers can borrow money from their 401(k) plans if their plan includes loan provisions permitting this activity. Some 401(k) plans do not offer loans to participants.When borrowers take out a 401(k) loan, they borrow money from their retirement savings and are generally expected to repay the loan within five years. These employees must make 401(k) loan repayments at least quarterly or face possible income tax consequences if they fail to do so.

How Does Borrowing Against a 401(k) Work?

Borrowing against a 401(k) works by allowing employees to borrow either 50% of their plan’s vested account balance or $50,000, whichever is less. For example, an employee with a vested account balance of $140,000 can borrow up to $50,000 from the retirement savings, while another employee with a vested account balance of $82,000 can borrow up to $41,000.Some 401(k) plans may include an exception allowing employees to borrow more than 50% of their vested account balance if their vested account balance is less than $20,000. Workers in that case could borrow up to $10,000 from their 401(k) plan.As mentioned earlier, borrowers who take out a 401(k) loan generally must repay the loan within five years. Borrowers are expected to make repayments on a 401(k) loan at least quarterly. Borrowers who fall short of the repayment obligations can have their remaining balance treated as a distribution subject to income taxation.Employees who resign or lose their jobs may be required to repay their remaining 401(k) loan balance within a short period to avoid possible tax consequences. Some borrowers who default on a 401(k) loan may face an additional 10% early distribution tax if they are under the age of 59½.

Pros and Cons of Personal Loans

Here are some pros and cons of personal loans:

Pros and Cons of 401(k) Loans

Here are some pros and cons of 401(k) loans:

Personal Loans vs 401(k) Loans

Consider the similarities and differences between a 401(k) loan vs. personal loan:

Weighing Which Is Best for Your Situation

Personal loans and 401(k) loans each carry advantages and disadvantages. Borrowers can weigh the pros and cons of a 401(k) loan vs. personal loan when deciding whether to consider one over the other. A 401(k) retirement plan may grow over time with compound interest. Given the nature of compound interest growth, 401(k) loans may diminish your retirement savings if the loan causes your plan to appreciate less.A personal loan can include high rates of interest and origination fees, which can make it harder for some borrowers to afford.

The Takeaway

Some employees with a 401(k) retirement plan may not have the option of taking out a 401(k) loan. For any employee considering a 401(k) loan to cover major expenses, other consumer lending products might also be a viable option.Lantern by SoFi can help you with exploring personal loan interest rates. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process to apply for a personal loan with the lender of your choice.
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Frequently Asked Questions

Is borrowing against your 401(k) the same as a loan?
Does a 401(k) loan go on your credit report?
How fast can you get a 401(k) loan?

About the Author

Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and currently serves as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.
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