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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 of Personal LoansCons of Personal Loans
One of the reasons to apply for personal loans is they can help borrowers build creditPersonal loans may increase your burden of debt
Personal loans can be signature loans that require good character and no collateralLenders may charge high rates of interest on personal loans
When considering secured vs. unsecured loans, borrowers with poor credit may qualify for secured personal loans by pledging an asset as collateralLenders may conduct a hard inquiry on your credit report if you apply for a personal loan, which can cause your credit score to drop a few points
Personal loans provide borrowers with a lump sum of money and few restrictions on how the money can be spentMissing a payment or defaulting on the loan could stain your credit history and make it harder to borrow money in the future

Pros and Cons of 401(k) Loans

Here are some pros and cons of 401(k) loans:
Pros of 401(k) LoansCons of 401(k) Loans
Borrowers can receive a lump sum disbursement up to $50,000The maximum loan amount on a 401(k) loan is $50,000, whereas personal loans and other consumer lending products may allow you to borrow up to $100,000 or more
Borrowers can use the 401(k) loan to cover planned or unplanned expensesDefaulting on a 401(k) loan can trigger burdensome income tax consequences, including an additional 10% early distribution tax if you are under the age of 59½
A 401(k) loan could feature low rates of interest, and any interest charges you pay may go back into your retirement planEmployees who take out a 401(k) loan and resign before repaying the loan in full may be required to pay off the balance within a short period.
Taking out a 401(k) loan does not require good credit, and defaulting on a 401(k) loan has no negative consequences on the borrower’s credit scoreSome 401(k) loans may require the written consent of the employee’s spouse or partner, because these loans can diminish a borrower’s retirement savings if the loan slows the growth of a 401(k) plan that typically appreciates over time with compound interest

Personal Loans vs 401(k) Loans

Consider 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 personal loans 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 what is a personal guarantee
Defaulting on a personal loan could stain your credit history and make it harder for you to borrow in the futureDefaulting on a 401(k) loan could subject you to burdensome income tax consequences

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.

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?
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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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