401(k) Loan vs. Personal Loan: What's the Difference? 

When you need cash quickly, you may not think of a 401(k) loan or a personal loan, but both may be good options. They can each get you the funds you need, but they work differently. Choosing the wrong one could cost you more than you might expect, either in interest or in lost retirement savings.

Read on to learn how each option works and compare the potential costs to determine which makes the most sense for your circumstances.

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Key Takeaways

• Both loan types can deliver cash quickly, but they work very differently — a 401(k) loan taps your own retirement savings with no credit check, while a personal loan is issued by a bank, credit union or online lender based on your credit profile.

• The real cost of a 401(k) loan goes beyond the interest rate — money pulled from your account can't grow in the market while it's borrowed, and leaving your job before repayment is complete could trigger income taxes and a 10% early withdrawal penalty.

• A personal loan keeps your retirement savings intact and can help build your credit history over time, but you'll need solid credit to qualify for a competitive rate; those with fair credit may face rates of 20% or higher.

• If you have strong credit and stable employment, a personal loan is generally the safer long-term choice — start by checking your rate with multiple lenders using a soft credit pull so your score isn't affected.

• If you can't qualify for a personal loan or need cash quickly, a 401(k) loan can be a reasonable short-term solution — confirm your plan allows loans and have a clear repayment plan before you borrow.

Summary generated by AI, verified by MoneyLion editors

401(k) Loan and a Personal Loan: Key Differences

Here’s a side-by-side comparison to help break down how 401(k) loans differ from conventional personal loans:

How Does a 401(k) Loan Work?

A 401(k) loan lets you borrow money directly from your retirement account and pay it back with interest over time. Think of it as borrowing money from yourself.

Here’s what to expect:

• Borrowing limits: You can typically borrow up to $50,000, or 50% of your vested balance, whichever is less. If your vested balance is $20,000, for example, you may be able to borrow up to $10,000.

• Repayment terms: Most plans require repayment within five years, though you can choose a shorter term. Payments are automatically deducted from your paycheck, so it’s easy to stay on track.

• Job separation risk: If you leave your job before the loan is fully repaid, you’ll often need to repay the remaining balance by your tax filing deadline. If you can’t, the unpaid amount is treated as a withdrawal. This means you’ll owe income taxes on the outstanding balance, plus a 10% earthy withdrawal penalty if you’re under 59 ½.

Not all 401(k) plans allow loans, so your first step is to check with your HR or benefits team.

How Does a Personal Loan Work?

A personal loan is money you borrow from a bank, credit union or online lender. There are many different types of personal loans, and you’ll repay them with fixed monthly installments over a set term, which often ranges from two to seven years.

Unlike a 401(k) loan, a personal loan is unsecured. That means there’s no collateral required, so lenders will rely heavily on a hard credit check. Approval could happen the same day, but it may also take several weeks, depending on the lender.

Here’s what to expect:

• Application and credit check: You’ll need to apply with a lender and provide proof of income. The lender will run a credit check, which can temporarily impact your score, and assess your financial standing and current debt-to-income (DTI) ratio.

• Interest rates: Rates will vary widely based on your credit. Borrowers with excellent credit may qualify for rates as low as 6% to 8%, depending on current market conditions, while those with fair credit scores could see rates of 20% or higher.

• Repayment structure: You’ll make fixed monthly payments over the lifetime of the loan. As long as you make payments on time, a personal loan can actually help you build your credit history.

It’s also worth noting that personal loan proceeds are generally not considered taxable income, though there are exceptions depending on how the funds are used.

How Much Can You Borrow With Each Option?

The amount you can borrow will depend on the type of loan you’re taking out and factors like your income or current vested savings.

401(k) Loan Limits

• The IRS caps 401(k) loans at the lesser of either $50,000 or 50% of your vested interest. That means if your vested balance is less than $20,000, you may be able to borrow up to $10,000.

• Keep in mind that only vested funds count. Your own contributions are vested immediately, but employer contributions may take up to five years to vest fully, depending on the details of your employer’s plan.

Personal Loan Limits

• Personal loan amounts typically range from $1,000 to $100,000, depending on the lender and your financial profile.

• Approval amounts are based on your credit score, income, DTI ratio and the lender’s own policies. Someone with excellent credit and a high income may qualify for much more than someone with limited credit history.

401(k) Loan vs. Personal Loan Costs: Quick Examples

Imagine you need to borrow $20,000 and plan to repay it over five years. Here’s how it would look for different loan types:

On the surface, the 401(k) loan looks like the winner. And in terms of out-of-pocket costs alone, it often is. However, you need to consider the sometimes overlooked cost of missed investment growth.

If that $20,000 had stayed invested and earned an average 7% annual return over five years, it could have grown to roughly $28,000. That $8,000 in missed growth is a real cost that doesn’t show up in the table above.

And when it comes to personal loans, your rate can vary significantly based on your credit score. As you can see from the table above, the interest rate you get makes an enormous difference in the cost of the loan. As a result, it’s worth shopping around and getting pre-qualified before committing to a lender.

What Are the Risks of a 401(k) Loan?

A 401(k) loan can feel like an easy, low-cost solution. Who wouldn’t love the idea that all that interest you’re paying ultimately gets put back into your account, after all?

However, it comes with risks and costs that you need to take seriously:

• Job loss can trigger immediate repayment requirements: If you’re laid off or leave your job, you may have to repay the full balance quickly. If you can’t, the outstanding amount owed becomes taxable income, and you’ll owe a 10% early penalty if you aren’t 59 ½ or older.

• You miss out on investment growth: Money that has been borrowed isn’t working for you in the market. In a strong market, this opportunity cost can be high.

• You may be selling low: If the market is down when you take the loan, you’re locking in losses by pulling money out before a potential recovery.

• Contribution disruption: Some plans restrict new contributions while you have an outstanding loan, which can set back your retirement savings further.

Pros and Cons of Each Option

There are both pros and cons to personal loans and 401(k) loans. Here's a breakdown of each.

401(k) Loan Pros and Cons

Personal Loan Pros and Cons

How Do You Choose Between a 401(k) Loan and a Personal Loan?

If you’re deciding between a 401(k) loan and a personal loan, here’s a quick guide that can help you assess which may be right for you:

• If you have strong credit → Consider a personal loan. You may qualify for a competitive rate, and it wouldn’t require you to touch your retirement savings.

• If you can’t qualify for a personal loan → A 401(k) loan may be your best option if your plan allows it.

• If your job situation is unstable → Be very cautious about a 401(k) loan, as the risk of forced repayment is real.

• If you’re within ten years of retirement → Lean toward a personal loan, as pulling from your 401(k) now could meaningfully impact your nest egg due to impacted growth and potentially restricted distributions during key catch-up contribution years.

• If you need money quickly → A 401(k) loan is typically faster, as there’s no application or underwriting process.

• If you want to build credit → A personal loan is the only option that helps your credit score, but this only happens if you make on-time payments.

• If your income is variable or you’re worried about making payments → A 401(k) loan’s automatic payroll deductions can make repayment more manageable.

How Do You Apply for Each Loan?

The application processes for 401(k) loans and personal loans differ significantly. Here’s how to apply for each.

Applying for a 401(k) Loan

1. Contact your plan administrator or HR department to find out if your plan allows loans and what the process involves.

2. In most cases, you’ll simply need to request a loan amount and set up a repayment schedule, with no application or credit check required.

3. Funds are typically disbursed within a few business days, though the timeline may vary if your investments aren’t yet liquid.

4. There may be a small processing fee, but the 401(k) loan isn’t a taxable event as long as you repay it on time.

Applying for a Personal Loan

1. Compare rates from the best banks for personal loans, as well as credit unions and online lenders. Many allow you to check your rate without impacting your credit score.

2. After choosing a lender, complete the full application and include documentation like pay stubs and tax returns.

3. The lender will run a hard credit inquiry, which can temporarily lower your credit score by a few points.

4. Approval and funding can take anywhere from a single business day to several weeks.

401(k) vs. Personal Loan FAQs

Which is easier to get, a personal loan or a 401(k) loan?

A 401(k) loan can be easier to receive, 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 — a personal loan or a 401(k) loan?

The rates are often comparable between personal loans and 401(k) loans if you have good credit, but it depends on the lender and current market rates. It’s worth noting, however, that you’ll pay the interest on a 401(k) loan back into your account, while personal loans pay interest back to the lender.

What happens if I leave my job while I have a 401(k) loan?

If you leave your job while you have a 401(k) loan, your plan may require that you repay the outstanding balance by the tax filing deadline for that year. If you can’t repay it, the remaining balance is treated as a taxable distribution and could face early withdrawal penalties.

Do personal loans affect credit?

A personal loan will appear on your credit report and affect your DTI ratio. 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 between 401(k) loans and personal loans?

Yes, you can take a personal loan to pay off a 401(k) loan, or vice versa. However, since there are fees involved, it's best to decide which one is best and stick with it.

Key Terms

• 401(k) loan: A loan you take from your own employer-sponsored retirement account, capped at the lesser of $50,000 or 50% of your vested balance. You repay it with interest through payroll deductions, typically within five years, and the interest goes back into your account.

• Vested balance: The portion of your 401(k) you own outright. Your own contributions vest immediately; employer contributions may take up to five years to vest fully, depending on your plan's schedule.

• Early withdrawal penalty: A 10% additional tax the IRS charges on distributions taken from a retirement account before age 59½, unless a qualifying exception applies. It's owed in addition to ordinary income tax on the withdrawn amount.

• Personal loan: An installment loan from a bank, credit union or online lender that you repay in fixed monthly payments over a set term, typically two to seven years. Most personal loans are unsecured, meaning no collateral is required.

• Debt-to-income ratio (DTI): Your total monthly debt payments divided by your gross monthly income, expressed as a percentage. Lenders use it to assess whether you can take on additional debt; most prefer a DTI of 36% or lower.

• Hard inquiry: A formal credit check a lender initiates when you apply for new credit. It can temporarily lower your credit score by a few points and stay on your report for two years.

• Opportunity cost: The potential investment return you give up when money is removed from your retirement account to fund a loan. Funds out of the market can't compound returns during the loan's repayment period.

Sources:

• IRS: Retirement Topics — Loans

• IRS: Topic No. 558, Early Distributions From Retirement Plans

• CFPB: What Is a Debt-to-Income Ratio?

• CFPB: What Is a Credit Inquiry?

Summary generated by AI, verified by MoneyLion editors

Karen Doyle contributed to the reporting for this article.

Jasmin Baron, CCC™, contributed to editing this article.

Photo Credit: Rido / Shutterstock.com