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Guide to 401(k) Loans vs Personal Loans

401(k) Loans vs Personal Loans
Sulaiman Abdur-Rahman
Sulaiman Abdur-RahmanUpdated April 8, 2023
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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 $100,000 personal loan offers.Personal loans and 401(k) loans each have their advantages and disadvantages. Below we provide more information about getting a personal loan vs. 401(k) loan 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.There are a variety of ways to use a personal loan, as mentioned above. A personal loan can help you finance home improvement projects, among other large purchases.

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.A 401(k) plan is similar to a Thrift Savings Plan (TSP), and 401(k) loans are similar to TSP loans. How is a 401(k) loan similar to a TSP loan? Both borrow from your retirement savings as opposed to borrowing from a bank, credit union, or private lender.

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

Below, we highlight some of the pros and cons of personal loans:

Pros of Personal Loans

  • Can help you build credit
  • Collateral is not necessarily required
  • Borrowers with poor credit may qualify for secured personal loans by pledging an asset as collateral

Cons of Personal Loans

  • May increase your burden of debt
  • Lenders may charge high rates of interest 
  • Applying for one can generate a hard inquiry, which can hurt your credit score
  • Missing a payment or defaulting on the loan could damage your credit 

Pros and Cons of 401(k) Loans

Below we highlight some of the pros and cons of 401(k) loans:

Pros of 401(k) Loans

  • You may borrow up to $50,000 from your retirement plan
  • Funds can be used to cover unexpected expenses 
  • May feature low rates of interest
  • The interest is paid back to yourself (minus fees potentially)
  • Defaulting on the loan has no negative consequences on your credit score

Cons of 401(k) Loans

  • The maximum loan amount is $50K
  • The money borrowed is taken out of the market and will not participate in any market gains, which will adversely affect the growth of the retirement funds
  • Defaulting can trigger burdensome income tax consequences, including an additional 10% early distribution tax if you’re under the age of 59½
  • Employees who resign may be required to pay off the loan balance within a short period
  • Loan approval may require the written consent of the employee’s spouse or partner in some cases

Personal Loans vs 401(k) Loans

There are similarities between a personal loan vs. 401(k) loan. If you need funding, it’s clear that borrowing from a 401(k) vs. personal loan can serve the same purpose.There are also distinctions, of course, between a personal loan vs. 401(k) loan and personal loan vs. 401(k) withdrawal. A 401(k) withdrawal is not the same thing as a 401(k) loan. Employees borrow against their retirement plan with a 401(k) loan and permanently remove money from their retirement savings with a 401(k) withdrawal.A personal loan is closed-end credit that you can borrow from a financial institution or private lender. It has no direct connection to your employment or retirement savings.The table below explores the similarities and differences between a 401(k) loan vs. personal loan:
Personal loans401(k) loans
Personal loans provide borrowers with a lump sum of money401(k) loans provide borrowers with a lump sum of money
Borrowers can use personal loans to help cover planned and unexpected expensesBorrowers can use 401(k) loans to help cover planned and unexpected expenses
Some lenders offer loan amounts up to $100,000The maximum 401(k) loan amount is $50,000
Personal loans can be secured or unsecuredBorrowers can take out a 401(k) loan without signing a personal guarantee

Secured vs Unsecured Personal Loan Trade-Offs

Personal loans can be secured with collateral or unsecured without collateral. Both secured vs. unsecured loans can help borrowers build credit, but secured loans reduce risk to the lender.Lenders may seize your collateral if you default on a secured personal loan. As such, the interest rate you get on a secured personal loan may be lower than the interest rate you get on an unsecured personal loan.Personal loan approval is never guaranteed, but pledging an asset as collateral may improve your personal loan approval odds.When considering a personal loan vs. 401(k) loan or a personal loan vs. 401(k) withdrawal, keep in mind that personal loans can be secured with collateral or unsecured.

Weighing Which Is Best for Your Situation

Personal loans vs. 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.If you’re weighing a 401(k) loan vs. personal loan, your personal circumstances may dictate which option is right for you. Going with a personal loan vs. 401(k) loan can help you build credit, while borrowing from your 401(k) can be an easy way to get funding without applying for open-end credit vs. closed-end credit.

Checking Out Your Personal Loan Interest Rate

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 lending products might also be a viable option to consider.Lantern by SoFi can help you find personal loan offers. 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.Compare personal loan rates with Lantern.

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?
Is it better to borrow from your 401(k) or take out a personal loan?
Do 401(k) loans build credit?
Photo credit: iStock/lightspeedshutter

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 served 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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