When you need a large sum of money to cover large expenses or to cover your expenses during an emergency, there are different loan options you can select from. A 4012(k) loan allows you to borrow money from your retirement account, while a personal loan offers large loan amounts. But when comparing 401(k) vs. personal loan, which is better?
A 401(k) loan is an easy and quick loan to take; the interest and payments made on the loan are eventually returned back into your account. A personal loan is a good option for borrowers who need to borrow a large sum of money or borrowers who do not want to tamper with their invested savings. Both loans are taken to meet the unforeseen financial needs of borrowers.
A personal loan allows you to borrow money without affecting your savings, while a 401(k) loan offers quick and cheap loans. These loans work in different ways and come with benefits and disadvantages. The best for you depends on your needs and what you prefer. This article will discuss 401(k) Loan vs. Personal Loan: Which Is Better.
What is a 401(k) loan?
A 401(k) loan is a loan type that allows borrowers to borrow from their retirement savings. This loan option is most times informal; you can request this loan just by logging in to your account through the administrator’s website and selecting the loan amount you want to take.
You may borrow up to 50% of your retirement savings, up to a maximum amount of $50,000, within a 12-month grace period. Immediately you get approved for a loan, the loan taken will be added to your next paycheck, and there you can access the money.
However, you will need to repay the loan taken within five years with interest. 401(k) loan interest rates are determined by the fund administrator, and these rates are calculated by summing up one or two percentage points to the new prime interest rates. Repayments are made quarterly if you are unemployed, and the whole loan balance may be due by the fixed tax-filing deadlines.
Benefits and Disadvantages of 401(k) Loan
Getting a 401(k) loan has its benefits and disadvantages. Some of its benefits include
- Smooth application process.
- Corresponding low interest rates.
- No impacted credit or credit check.
- There are also some disadvantages to getting a 401(k) loan. These disadvantages include:
- Missing out on earnings.
- Expensive default.
- It might not be an option.
These are some of the reasons why these loans may not be a good idea for borrowers.
What are Personal Loans?
Personal loans are types of loans that offer huge sums of money as loans to borrowers and are to be repaid in installments over the loan life. These installments usually last between two and seven years. Personal loans are flexible loans because they can be taken and used for any reason, like home improvements or consolidating debts with high interest rates.
This loan allows borrowers to borrow a large sum of money, such as an amount ranging from $1,000 to $50,000 and even $100,000. The personal loan application process is quite different from that of a 401(k) loan. You will need to find a lender and then apply for a personal loan under them.
Personal loan lenders do credit checks on borrowers before approving their loans. These lenders may also require you to provide some documentation, like pay stubs and tax forms, to verify your income. Unfortunately, some lenders have limits on what you can spend your loan on.
Benefits and Disadvantages of Personal Loans
A personal loan is an amazing option if you need a large sum of money, but there are benefits and disadvantages to getting this loan. Some personal loan benefits include:
Certainly high loan amounts.
- Your savings won’t be affected.
- While these are the benefits, below are some disadvantages to getting personal loans.
- Affects your credit score.
- High-interest costs.
These are some things you need to consider before processing a personal loan.
Should I get a 401(k) loan or a personal loan?
A 401(k) loan and a personal loan are applicable options you can select from when you need quick cash. Borrowing from your retirement account is a faster process to get quick cash because it requires no credit check and comes at a low cost, while it’s the opposite for personal loans.
But as stated earlier, if you need a large sum of money, a personal loan is a good idea to consider. It is also a good idea if you need a longer repayment term or if you do not want to risk your savings and investments. Using the below strategy, determine if you need a personal loan or a 401(k) loan.
- The loan term is best for you.
- Your credit score.
- The loan amount you need.
- Stability of your job.
- How much savings in your 401(k)?
These strategies should help you make a better decision on what loan you should get.
401(k) Loan vs. Personal Loan: Which Is Better?
The table below shows the differences between 401(k) loans and personal loans side by side.
| 401(k) Loan | Personal Loan | |
| Qualifications | Borrowers must have an endowed balance in a 401(k) plan which allows loans. | A good credit score is required. Enough income to manage your current debts and loans taken. |
| Loan Amount | $50,000 or 50% of the endowed balance depending on which is less. | About $200,000 is offered depending on your personal loan lender but depending on your credit, the loan amount you qualify for is determined. |
| Interest Rates | Prime rate plus 1% to 2% (the interest you are to pay with your 401(k). | Between 6% to 36% APR. |
| Terms | Up to five years. | Between 1 to 7 years. |
| Credit Impact | None | Initial dip in credit score. |
| Tax Consequences | Liable to income tax and a 10% early withdrawal penalty if the loan repayment is late. | None |
| Retirement Consiquences | Certainly reduced retirement funds even after the repayment. | None |
These are the differences between a 401(k) loan and a personal loan. using these differences you can determine the loan best for you.
