When you need access to extra funds, it can be tough to choose the right loan. One of the biggest decisions people face is whether to take a personal loan or borrow from their 401(k). Each option has its own set of benefits and risks. This guide will break down the key differences between a 401(k) loan vs. personal loan so you can make confident and informed choices benefiting your financial goals.
What is a 401(k) loan?
A 401(k) loan lets you borrow money from your retirement savings. While it may seem strange to borrow from yourself, this type of loan can provide a quick and simple way to access cash.
When you take a 401(k) loan, you borrow directly from your retirement account and repay the amount with interest over time—usually within five years. Payments are often deducted from your paycheck, making repayment automatic. The interest rate is typically based on the current prime rate plus one or two percentage points.
Pros of a 401(k) loan
- No credit check required: Since you’re borrowing from your own savings, there’s no need for a credit score review.
- Lower interest rates: Interest is usually lower than what you’d find with unsecured loans.
- You pay yourself back: The interest you pay goes back into your retirement account.
Cons of a 401(k) loan
- Reduced retirement growth: While the money is loaned out, it’s not invested and won’t grow.
- Repayment risks if you leave your job: If you leave your job or are laid off, you may have to repay the full balance quickly or face penalties.
- Tax implications: If you don’t repay on time, the loan may be treated as a withdrawal and taxed as income. Plus, you could face a 10% penalty if you’re under 59½.
What is a personal loan?
A personal loan is an unsecured loan offered by banks, credit unions, and online lenders. These loans can be used for almost any purpose, including debt consolidation, medical bills, or emergency expenses.
Personal loans are repaid in fixed monthly payments over a term that usually ranges from 1 to 7 years. Interest rates and loan amounts depend on your credit score, income, and other financial factors.
Pros of a personal loan
- Preserves your retirement savings: Your 401(k) stays untouched and continues to grow.
- No job-related repayment risks: You won’t have to repay the loan early if you leave your job.
- Flexible use: Funds can be used for a wide range of needs.
Cons of a personal loan
- Credit check required: Approval depends on your credit score and financial history.
- Higher interest rates: Especially for borrowers with lower credit scores.
- Possible fees: Some lenders charge origination fees or prepayment penalties.
Read more: What are Small Personal Loans?
401(k) loan vs personal loan: A side-by-side comparison
| Feature | 401(k) Loan | Personal Loan |
| Source of Funds | Your retirement savings | Banks, credit unions, online lenders |
| Credit Check | Not required | Required |
| Interest Rates | Lower; paid to yourself | Varies; paid to lender |
| Impact on Retirement | Temporary setback | No impact |
| Repayment Terms | Up to 5 years | 1 to 7 years |
| Loan Purpose Restrictions | None | Usually none |
| Tax Penalties | Possible if unpaid | None |
| Early Repayment Risk | Yes, if job ends | No |
When might a 401(k) loan make sense?
A 401(k) loan could work for you if:
- You have poor credit and might not qualify for a personal loan.
- You need the money quickly and want a simple application process.
- You’re confident you can repay the loan on time without disrupting your retirement plan.
However, borrowing from retirement savings should be a last resort. Think of it as borrowing from your future.
When is a personal loan the better option?
A personal loan might be the smarter choice if:
- You want to preserve your retirement savings.
- You have good credit and can qualify for a competitive interest rate.
- You prefer flexible repayment terms and no early repayment penalties.
Personal loans can also be a great fit for consolidating high-interest debt, making home improvements, or handling large expenses without dipping into long-term savings.
Making the decision that’s right for you
Your choice between a 401(k) loan and a personal loan depends on your financial situation, credit standing, and long-term goals. While a 401(k) loan might be easier to access, it can come with hidden costs to your future retirement. A personal loan could help you keep your investments intact while still getting the money you need now.
Before you borrow, ask yourself:
- Can I afford the monthly payments?
- What will the total cost of the loan be?
- How will this decision affect my long-term financial plans?
If you’re unsure which option is right, consider speaking with a financial advisor.
The bottom line
Deciding between a 401(k) loan and a personal loan isn’t always easy. But when you understand how each works, you can make a more confident choice. A 401(k) loan can offer fast access to cash with low interest, but it comes with risks to your retirement. A personal loan can be a smarter way to borrow if you’re focused on preserving your financial future.
This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.
