Did you have an unexpected expense pop up and need cash fast? Or maybe you need money for home renovations, debt consolidation, or paying off costly medical debt. Whatever the reason is, you may have been thinking of whether you should dip into your 401k or take out a personal loan. So, what are the differences between a 401k loan vs personal loan, and which would be best for you?
This guide will discuss the differences between 401k loans vs personal loans, how they work, and the pros and cons of each. Let’s dive in so you can decide which loan will be best for your situation.
How Does a 401k Loan Work?
A 401k loan is when you borrow money against your 401k retirement account. You may be able to take out a loan from your 401k if your employer offers this as an option.
You can borrow up to 50% of your savings balance or up to $50,000. Loan terms can be up to five years for repayment.
For instance, if you have $25,000 saved in your 401k, you could borrow up to $12,500. You do have to pay interest on the amount you pay back; however, rates are typically cheaper than a personal loan, and it is deposited back into your 401k.
So, one benefit is you are paying yourself interest rather than a lender.
A 401k loan is different than a withdrawal because if you pay your loan back on time, there are no penalties or taxes collected on the amount you borrow.
But if you leave your job or are laid off, you will be required to pay back the loan within 60 days rather than the full loan term. This can result in a 10% fee if you are under 59 ½ years of age, and you will have to pay your effective tax rate on the remaining loan balance.
Keep this in mind when comparing a 401k loan vs personal loan.
How Does a Personal Loan Work?
Personal loans are a bit simpler in how they work, and the great thing about them is you don’t have to take money out of your retirement fund for the money you may need. A personal loan is also known as an unsecured loan.
This means you don’t need collateral to borrow money as you do with a 401k loan, auto loan, or mortgage. The loan is determined by things such as your credit score, income, and the amount of debt you already have.
These things will help lenders decide if you qualify for the loan and what your interest rate and terms will be.
So, if you have an excellent credit score and your debt-to-income ratio is within 36%, you may qualify for an affordable personal loan.
A personal loan would look something like this. Let’s say you borrow $15,000 as a personal loan vs a 401k loan. With a 5% interest rate for a five-year term, you would pay $1,984.11 in interest.
Although you have to pay interest to the lender and not yourself, you are not risking the chance of having to pay taxes and penalties like you would with a 401k loan. Not to mention the loss you will take on your retirement fund earnings.
That in itself can be reason enough to consider a personal loan over a 401k loan.
401k Loan vs Personal Loan: Which One is Better?
So, how do you decide whether a 401k or personal loan is better for you? Well, it’s time to weigh the pros and cons of each loan so you can make the best decision based on your financial situation.
Let’s dive into the pros and cons of a 401k loan first.
Pros of a 401k Loan
- Low-interest rates, and the interest is paid back to your 401k account.
- It doesn’t affect your credit score.
- The application process is simpler than a bank loan.
- You can access funds quickly.
Cons of a 401k Loan
- If you default on the loan, it can result in a 10% penalty plus taxes.
- You will lose money on your retirement fund because you are removing it from your investment account.
- Not all employers participate in 401k loan programs.
Pros of a Personal Loan
- You don’t need collateral to attain a personal loan.
- Higher loan limits than a 401k loan. Some lenders offer up to $100,000 depending on your qualifications.
- A personal loan can help improve your credit score by making on-time payments.
- Lower interest rates than credit cards.
Cons of a Personal Loan
- You need a good credit score to get an affordable rate.
- There may be origination fees associated with the loan.
- If you pay late, you will have to pay late fees-unlike a 401k loan.
- Payments may be higher than a credit card, even if the interest rate is low, because it is a fixed monthly payment with a set loan term.
After you compare the pros and cons of a 401k loan vs personal loan, then it’s time to calculate which one will be better for you.
Use Loan Calculators to Help You Decide
When it comes to making any personal finance decision, it’s essential to do the math. Before choosing a loan, you should use various 401k loan vs personal loan calculators to see which will be the smarter financial decision for your situation.
Here is a list of 401k loan and personal loan calculators to choose from:
Voya Retirement Plan Loan Calculator
Experian Personal Loan Calculator
Credit Karma Simple Personal Loan Calculator
You can use these 401k loan vs personal loan calculators to see how much each loan will cost. You can also assess the potential losses you may face from borrowing from your retirement fund with the help of Bankrate’s 401k calculator.
Get an Affordable Loan with Stately Credit Instead of Dipping into Your Retirement Fund!
Although borrowing from your 401k may seem like an easy solution, it can be quite risky and cost you more money in the long run. Consider what you would do if you lost your job and you had the possibility of defaulting on the loan. Also, the amount you will lose on your 401k investments.
Rather than taking a chance, why not apply for an affordable personal loan right here at Stately Credit? We offer interest as low as 5.9% APR for loan terms between 6-36 months, and you can borrow up to $25,000!
Plus, your payments are made via salary deductions and are designed to help you improve your credit score. It’s a win-win! Click here to learn more about the process and to apply easily!
Which Loan Will You Choose?
Now that you know the pros and cons of a 401k loan vs personal loan, you can make a wise choice on what type of loan is best for you.
Use the listed 401k vs personal loan calculators to determine how much each loan would cost. Don’t forget to assess the potential loss on investments you may acquire too.
Since saving for retirement is hard enough, consider skipping the 401k loan and apply for one of our reasonable personal loans. Your loan can get funded within 48 hours of applying, and you will not have to take funds from your future nest egg!
