401(k) Loan vs. Personal Loan: What’s the Difference?
Written by
Karen Doyle
Edited by
Melanie Grafil
Commitment to Our Readers
GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.
20 Years
Helping You Live Richer
Reviewed
by Experts
Trusted by
Millions of Readers
In short, a personal loan is an unsecured loan you get from a bank. You have to qualify for it, and you pay it back, with interest over a fixed length of time. A 401(k) loan is, as the name implies, a loan against your 401(k) retirement account. You pay the loan back to your account, with interest, over a fixed period of time.
Key Differences Between a 401(k) Loan and a Personal Loan
| Feature | 401(k) Loan | Personal Loan |
|---|---|---|
| Funds received | Up to the lesser of 50% of your account balance or $50,000 | Amount you qualify for |
| Interest type | Fixed, paid to your account | Fixed, paid to the bank |
| Collateral required? | No | Typically not |
| Best for | Younger borrowers | Short term needs |
| Credit needed | No | Yes |
What Is a 401(k) Loan?
A 401(k) loan lets you take money out of your 401(k) account and pay it back into the account, with interest over time. Not all plans allow loans, so check with your HR or benefits team to see if you can take a 401(k) loan.
Typically, you can borrow up to $50,000 or half of your vested 401(k) balance, whichever is less. If your vested balance is less than $20,000, you can often borrow up to $10,000 or your full balance. Note that your contributions are vested immediately, but employer contributions can take up to five years to be fully vested, which means that the funds are available to you.
When you pay back a 401(k) loan, you make the payments back into your 401(k) account. This is usually done automatically through your payroll, so your loan payment and interest will be deducted from your paycheck. You will usually have to pay the entire loan back within five years, but you can choose a shorter repayment schedule.
If you leave your job before the loan is fully paid off, you’ll have to pay it off at that time, or it will be considered a withdrawal and therefore taxable. If you are under 59½, you’ll also pay a 10% early withdrawal penalty.
What Is a Personal Loan?
A personal loan is a loan you get from a bank, credit union or other lender. It is usually unsecured, which means there is no collateral. In this sense, it’s different from a mortgage or a car loan as those are secured by the property you’re buying. Since these loans are not secured, the interest rate is usually higher than it would be for a secured loan.
To get a personal loan, you will need to apply to the lender and be qualified. This means you need to show that you have enough disposable income to make the payments, and your credit report must show that you have used credit responsibly in the past. If you’re living paycheck to paycheck and have maxed out your credit cards, you may not qualify for a personal loan.
How Does a 401(k) Loan Work?
Getting a 401(k) loan is fairly easy. Check with your benefits manager for details, but it typically involves requesting the amount and setting up a payment plan. You can choose the length of your repayment. Shorter is better, of course, but don’t agree to payments you can’t handle. There may be a small fee to process the loan, but it’s not a taxable event.
When the payments are deducted from your paycheck each pay period, they go back into your 401(k) account. This is one reason people prefer a 401(k) loan — you’re essentially paying interest to yourself. Keep in mind that you’ve taken money out of your retirement account so it’s not getting returns for you.
How Does a Personal Loan Work?
A personal loan requires you to find a lender and complete an application. You’ll need to provide proof of your income and expenses, and the lender will check your credit. You may have some input into how long you have to make payments, but the lender may put limits on this.
Pros and Cons of Each Option
There are advantages and disadvantages to both a 401(k) loan and a personal loan, and one may be better than the other in certain situations. Here are the pros and cons of each.
Pros of 401(k) Loans
- You’re paying interest to yourself.
- No credit check is required.
- You’re guaranteed to be approved.
Cons of 401(k) Loans
- You’ll reduce your retirement savings balance.
- Depending on timing, you may be withdrawing when the market is high.
- If you leave your job, you need to pay back the loan or be taxed on it.
Pros of Personal Loans
- Your retirement account balance stays intact.
- Paying the loan off on time can boost your credit score.
- It doesn’t matter if you switch jobs.
Cons of Personal Loans
- You have to qualify.
- Interest rates can be high because it’s unsecured.
How To Choose the Right Option for You
| If you… | Go with… |
|---|---|
| Have many year until retirement to recoup gains | 401(k) loan |
| Don’t want to touch your retirement savings | Personal loan |
| Are able to qualify for a bank’s terms | Personal loan |
| Don’t want or can’t pass a credit check | 401(k) loan |
| Like the idea of paying interest to yourself | 401(k) loan |
How To Apply for a 401(k) Loan or a Personal Loan
Most of the time, he only requirement to qualify for a 401(k) loan is that you have enough money in your account and that you don’t currently have a loan outstanding. You shouldn’t need an application or credit check, however, since you’re borrowing your own money.
A 401(k) loan is typically disbursed in a matter of days — if your assets are invested, shares may need to be sold and settled, and then the funds can be sent by check or direct deposit.
For a personal loan, you will need to complete the bank’s application, either online or in person. They will ask about your income and expenses, and they will run your credit report. The approval process may take a week or two, and you’ll likely have to sign a note before the funds will be disbursed.
401(k) Loan vs. Personal Loan FAQ
Here are answers to some of the most frequently asked questions on the differences between a 401(k) loam and a personal loan.- Which one is easier to get, a personal loan or 401(k) loan?
- A 401(k) loan is easier to get, since you are borrowing your own money. There's no application or credit check, and you don't have to wait for a decision.
- Which has lower interest rates?
- Interest rates are comparable, so check the rates for your specific options. When you borrow against your 401(k) you're paying the interest back into your retirement account. With a personal loan you're paying it to the bank.
- Can I use either for home repairs?
- You can use the money from either a 401(k) loan or a personal loan for any purpose.
- How do they affect credit score?
- A personal loan will show up on your credit report as a liability. When the lender pulls your credit report, it will show as an inquiry. The balance will remain on your report until it's paid off. If you make all your payments on time, it should improve your credit history.
- Can I switch from one to the other later?
- You could take a personal loan to pay off a 401(k) loan, or vice versa. Given that there are fees involved, it's best to decide which one is best and stick with it.
