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401(k) loans explained

There’s no credit check, but it can be risky business.

401(k) loans can be a low-cost borrowing option. However, withdrawing from your 401(k) can run the risk of having a not-so-comfy retirement, so consider alternatives.

What is a 401(k) loan?

A 401(k) loan is money that you borrow from your company-sponsored retirement account. Like other loans, you’ll pay back principal plus interest. But a 401(k) loan isn’t technically a loan.

Essentially, you’re withdrawing money from your 401(k) and you repay it all within the term — typically maxed out at five years. There’s also no lender or credit check.

The lack of credit check is often what makes 401(k) loans attractive to so many borrowers, and you won’t have to fill out a typical loan application. 401(k) loans also tend to come with lower interest rates than other borrowing methods.

But it’s not the most ideal borrowing option. Pulling money from your 401(k) can get expensive if you switch jobs or have trouble making repayments. Because most people don’t have enough in their retirement savings to begin with, a 401(k) loan may also make retiring more difficult down the road.

How much can I borrow?

Most 401(k) plans won’t allow you to borrow more than $50,000 or 50% of your account balance, whichever is less. If your account balance is lower than $20,000, you could borrow up to $10,000 but you’ll likely have to provide collateral. Some employers also set minimums on how much you can borrow — usually $1,000.

Typical 401(k) loan amounts:

Account balanceHow much you can borrow
$100,000+$50,000
$70,000$35,000
$20,000$10,000
$15,000$10,000 with collateral

Watch out: Your employer can restrict how you use your 401(k) loan

The IRS allows employers to limit the reasons that an employee can use to borrow against their 401(k). If your employer does, it’s not uncommon to them limit your loan for use toward:

  • Education expenses for yourself, a spouse or a child
  • Medical expenses
  • Housing expenses, including mortgages and eviction prevention

Be sure to check with your employer first before borrowing against your 401(k).

How much a 401(k) loan costs

401(k) loans are regulated by the IRS, but your loan terms are ultimately determined by your employer.

The interest rate on most 401(k) loans is the prime rate plus 1%, though your exact rate depends on your employer. The prime rate is what many financial institutions give to the most creditworthy applicants, typically hovering around 3% or 4%.

All interest you pay goes back into your 401(k) account. But returns are usually higher than the interest you’re paying, so it doesn’t make up for losses.

Most 401(k) loans come with five-year repayment plans, with the exception of mortgages. The IRS doesn’t specify how long your mortgage can extend, so your repayment term depends on your employer.

Try out our 401(k) calculator to play around with APRs, terms and amounts to calculate how much it may cost you.

When is the best time for a 401(k) loan?

If you’re far from retirement, you may have plenty of time to repay and be able to recoup any potential losses from withdrawals. But on the flip side, you may not have a large enough balance to borrow yet. If you’re less than five years from retirement, taking on a 401(k) may not be a good idea. You may not have enough time to repay or recoup from potential losses.

Some say the best time to borrow out of your 401(k) economy-wise is during a recession. The thought process is that if your 401(k) is in stocks during a recession, it’s not growing much anyway.

Regardless of how far away you are from retirement, or what the economy is like, borrowing out your 401(k) is largely considered a last resort lending method. Only take on a 401(k) loan if you’re sure you can repay it on time.

Can I withdraw funds from my 401(k) instead of taking on a loan?

You can, though it’s probably not a good idea since you’ll be hit with a 10% early withdrawal penalty if you’re under the age of 59 and a half. You can learn more with our guide on taking money out of 401(k).

401(k) loan application process

Taking out a 401(k) loan is not as complicated as with other loans. Start by setting up a meeting with your HR department to discuss your options. During your meeting, make sure to:

  1. Discuss the reason you want the loan, and confirm that reason isn’t restricted by your employer.
  2. Review your 401(k) account and figure out how much you can borrow.
  3. Learn what your interest rate will be.
  4. Request early or extended repayments if a five-year loan term doesn’t make sense for the amount you’re borrowing.
  5. Ask about repayments, which are typically deducted from your paycheck after taxes.

Your employer might ask you to complete forms before receiving your funds, but it’s nothing as extensive as a typical loan application.

What’s the turnaround time for a 401(k) loan?

It usually takes at least one week for your 401(k) loan to be disbursed, but it could take two weeks or more. Like most aspects of a 401(k) loan, it depends on how quickly your employer can process your request.

Pros and cons of 401(k) loans

Pros

  • No credit check. Your credit score isn’t a factor in eligibility.
  • Low rates. 401(k) loans typically come with lower interest rates than other borrowing methods, such as credit cards and unsecured loans.

Cons

  • Risky if you lose your job. If you get laid off or quit your job, you have two to three months to pay back your entire loan before you default.
  • Lose protection from bankruptcy. Funds in your 401(k) are protected from bankruptcy as long as they’re still in the account. But once they’re borrowed in the form of a loan, your funds are no longer protected.
  • You’ll pay taxes. 401(k) funds are tax-deferred until you withdraw from it. When repaying the loan, your employer deducts taxes first before withdrawing your repayment from your paycheck. And you still have to pay taxes later when you retire.
  • Loss on investment returns. The less money you have in your 401(k) balance, the less you’ll get in returns. Even if you repay your 401(k) loan on time, you won’t have gained as much from interest as you would if you left your account alone.
  • Contribute less or not at all. You can still contribute to your 401(k) while you’re repaying the loan, but you might not have the funds to do so. This can cost you thousands in retirement savings if you don’t repay the loan quickly.

Alternatives to 401(k) loans

You might want to rule out the following options before taking out a 401(k) loan:

  • Personal loans. Personal loans allow you to borrow anywhere from $1,000 to $100,000 — depending on your credit and if you choose to provide collateral. However, rates may be higher than 401(k) loans.
  • Vehicle title loans. If you own a vehicle outright, you may be able to put it up as collateral on a vehicle title loan. These are typically short-term loans, and watch out for high rates.
  • Cash advance apps. Within the realm of payday loans, cash advance apps offer short-term loans meant to get you through until your next payday.
  • Thrift Savings Plan loans. If you are a federal government employee or a uniformed service member, you can borrow against your Thrift Savings Plan. However, it has many of the same drawbacks as a 401(k) loan.
  • Other investments. If you have other investments, such as cryptocurrency, consider cashing those in first.
  • Crowdfunding. Set up a campaign on a crowdfunding platform and ask friends, family and members of your social network to make small donations toward covering your expenses. Many crowdfunding sites are suited for small businesses as well.

Compare personal loans

To start the comparison process, select your credit score range and state, then click Show me my personalized options to view lenders.

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Bottom line

The low interest rate and easy application process might make 401(k) loans sound like an attractive option. But even those with job stability and impeccable personal finances aren’t completely safe from risk. Take caution when considering this borrowing option — and read our guide to personal loans to learn more about your other loan options.

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