401k loan vs personal loan: which is right for me?
Life happens. Whether planned or unplanned, situations may arise where you need money before you’ve earn it. You may want to pay off credit card debt or medical bills, pay for a home improvement or car repair, or invest in yourself (car repair, wedding, or a much-needed vacation).
Once you find yourself in that situation, you’ll likely look around for available sources of money. This could be money in a savings or retirement account, a loan from a family member or friend, or a loan from a bank or lender. Quite often, two frontrunners emerge that offer the quickest possible solution and the utmost privacy – a Personal Loan or a 401(k) Loan.
Do you already know that a personal loan is the right option for you? Take a look at the loan options from Guaranteed Rate and check your rate today!
Personal Loan vs. 401(k) Loan
These types of loans are similar in many ways and very different in others. You can apply for each one through a different lender.
What is a Personal Loan?
A personal loan is an agreement between you and a lender, be it a fintech company like Guaranteed Rate, or a bank or credit union. “Personal” is one of the top selling points for these loans – unlike a car or home loan, what you do with this money is your business and nobody else’s. These types of loans are typically “unsecured”, which means you do not need to put your house, car, boat, or other asset as collateral to get the money.
How does a personal loan work?
- In your loan application, you’ll ask a lender for money you’ll need. Once approved, you’ll agree to loan terms to receive your funds in a lump sum which you then repay in a set number of monthly payment or installments.
- You’ll pay back both the principal (the money borrowed) and interest (fees paid to the lender) monthly.
- A fixed rate personal loan locks in the interest rate for the life of the loan, so even if interest rates go up nationally, you can rest assured knowing you’ll pay back the same amount every month.
- Look for personal loans without “early repayment penalty”, so if you can pay down the principal early, you’ll save money on interest.
- It’s also a good idea to be mindful of if a lender has other fees. Additional fees can add up if you’re not watching closely when comparing options.
What is a 401(k)?
A 401(k) is a retirement savings plan offered by your employer. You pay into it with money that’s deducted from your paycheck before taxes are calculated and deducted. For some plans, the employer may match your contribution up to a certain amount or percentage of your earnings.
Typically, these plans grow in value over time. When you retire, you can withdraw money from these accounts at favorable tax rates, without penalties. Should you cash out your 401(k) balance (in full or in part) before the legal retirement age (59½), you will pay taxes and other IRS penalties on this income.
As your account balance grows, you may ask yourself, “if it’s my money, can I borrow from my 401(k)?” The answer is a definite “maybe”. Employers manage their 401(k) plans and may or may not allow loans based on a variety of factors, including plan structure, your length of employment, and how much you need to borrow. So, if you can take out a 401(k) loan, what are the key advantages and disadvantages of them? Let’s go through the key differences and benefits of a 401k loan and a personal loan.
What is a 401(k) loan?
A 401(k) loan is arranged through your employer* to tap into the retirement savings you have already built up in your account. Once you take out the loan, you start to repay on an agreed upon monthly schedule. Both principal plus interest goes back into your account, not to a lending institution. Now it may seem like a better deal to pay interest to yourself, compared to a lender, but there are some cons you should consider.
Disadvantages of a 401(k) loan
- Any money taken out of your account today isn’t in the financial market and growing. You will need to sell off mutual funds and bonds you already own, shares you likely paid for at a lower cost a while back, and repurchase shares at current market value as payments are remade.
- If you switch employers or lose your job before your loan is repaid, you will face a much quicker deadline to repay your loan to avoid taxes and penalties on the outstanding balance. In this scenario, the revised deadline is because your loan rests with your former employer, regardless if you roll over your remaining 401(k) balance to your new employer or to an IRA (individual retirement account).
Retirement savings plans are a long-term investment strategy, so it is best to keep that money on track by using a personal loan to pay off a short-term debt.
Why choose a personal loan?
Do you need money for an emergency? You don’t need to borrow against your 401k. You can get the funds you need without interrupting your long-term retirement goals by using a personal loan.
Guaranteed Rate makes it easy to see what loan terms are currently available; you can calculate the total cost of your potential loan based on selected options. Best of all, you can review available rates without affecting your credit score.
At Rate.com you can securely fill out your online application within minutes, get approved within 60 seconds, and receive your money within 1-2 business days of approval. Learn more about available personal loan options from Guaranteed Rate and apply when personal loans are available in your area.
All information provided in this publication is for informational and educational purposes only, and in no way is any of the content contained herein to be construed as financial, investment, or legal advice or instruction. Guaranteed Rate, Inc. does not guarantee the quality, accuracy, completeness or timelines of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error-free. Some information in the publication may have been provided by third parties and has not necessarily been verified by Guaranteed Rate. Guaranteed Rate its affiliates and subsidiaries do not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tort (including negligence) or other tortious action.
*If you’re self-employed and/or participate in an investment similar to a 401(k), such as a solo 401(k) or an IRA, you can check with your plan manager to see if loan options exist.