Whether you need to borrow money or you’re looking for ways to boost your credit score, you might be thinking about getting a loan. When it comes to a 401(k) loan versus personal loan, though, you might not know which one is better for you.
If you want to know the difference, here’s some information to help you choose between the two options.
What’s a 401(k) loan?
A 401(k) loan is a loan from your future self. It’s not a typical loan since you’re not borrowing money from a bank or lender. Instead, you’re borrowing from what should be your retirement savings. Levi Sanchez, a co-founder of Millennial Wealth, said there’s an unpredictability factor in borrowing from yourself.
“The major risk to 401(k) loans is the opportunity cost of tax-deferred growth in your account,” he said. “If you take a $50,000 loan from your 401(k) and the market rises 20% as it did in 2017, you’re missing out on $10,000 worth of growth in your account!”
Also, borrowing from yourself ties you down to your current employer, Sanchez said. If you change your company or get fired, you’ll have a small repayment window.
“If you leave [your job] before paying off the loan, you’ll owe ordinary income tax plus the 10% early-withdrawal penalty on the outstanding loan balance if [it’s] not repaid within 60 days, resulting in a potentially devastating tax bill that sets you back years in your retirement savings,” he said.
One in five Americans doesn’t have any money saved for retirement, according to a recent study from Northwestern Mutual. So if you don’t have anything saved in a retirement fund, a 401(k) loan won’t be possible.
What’s a personal loan?
A personal loan usually is an unsecured loan. No collateral is required when applying for a personal loan, but your creditworthiness is evaluated to see how responsible you are with money. Personal loans are different from typical secured loans, such as a car loan or a mortgage. Personal loans tend to have higher interest rates than secured loans as well as some other loans, such as student debt. But the rate varies depending on your creditworthiness. The better your credit score, the lower the interest rate in your repayment terms.
“Oftentimes, personal loans are used to consolidate and pay off higher-interest debts associated with credit cards,” Sanchez said. “If your credit score is strong, you can take out a personal loan to pay off higher-interest-rate credit cards and pay back the personal loan at a lower rate.”
Unlike 401(k) loans, personal loans require you to submit an application to a bank or lender, undergo a credit check, and pay back the loan with interest. And while employment and income information is verified, you don’t have to worry about staying with an employer, as you do with a 401(k) loan.
401(k) loan vs. personal loan: Which is better?
You need to know the purpose of your loan if you’re trying to decide which option is better: a 401(k) loan versus personal loan.
“Everyone’s situation is different; however, if you’re using 401(k) loans or personal loans to consolidate debt, in most cases a personal loan will be the better option, given a decent credit score,” Sanchez said. “The opportunity cost of tax-deferred growth is just too great when compared to a personal loan and the potential higher-interest-rate payments.”
While personal loans tend to have higher interest rates and shorter repayment terms, borrowing against your retirement is a bigger risk than you might be willing to take.
It might seem tempting to borrow from your 401(k), especially if you need money right away and don’t have a solid credit score to get a personal loan. But even if you have poor credit, you could get a personal loan.
The repayment can vary depending on your employer, but generally, you’re responsible for paying back your 401(k) loan within five years. If you have a medical emergency or other hardship, borrowing from your future self instead of getting a bank loan could work for you. But you might not have enough cash saved in your retirement fund to borrow from it. Keep that in mind as you’re exploring immediate options for a loan.
Be cautious with your choice
Regardless of which kind of loan you decide to take out, review your options carefully. If borrowing against your 401(k) will hurt you financially in the long run, seek other alternatives, such as a personal loan. If you don’t think you can get approved for a personal loan, look for lenders that accept borrowers with cosigners.
Interested in a personal loan?Here are the top personal loan lenders of 2018!
|Lender||Rates (APR)||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
|7.73% – 29.99%||$1,000 - $50,000|
|6.28% – 14.87%1||$5,000 - $100,000|
|6.87% – 35.97%*||$1,000 - $50,000||Visit Upgrade|
|8.00% – 25.00%||$5,000 - $35,000|
|4.99% – 29.99%||$10,000 - $35,000||Visit FreedomPlus|
|5.99% – 18.99%2||$5,000 - $50,000||Visit Citizens|
|15.49% – 34.49%||$2,000 - $25,000||Visit LendingPoint|
|5.99% – 35.89%||$1,000 - $40,000||Visit LendingClub|
|5.49% – 18.24%||$5,000 - $75,000||Visit Earnest|
|9.95% – 35.99%||$2,000 - $35,000||Visit Avant|