Personal Loan Vs. Borrowing Against Your 401(k)
Two of the most common ways to boost a budget include taking out a personal loan or borrowing against a 401(k).
Although they serve the same purpose, each has its pros and cons. Read on for a breakdown of 401(k) loan vs a personal loan.
Knowing the difference between the two will give you a better idea as to which is the best option for you.
How Does Borrowing From Your 401(k) Work?
A 401(k) is a retirement plan that allows an employee to redirect a percentage of their salary into long-term investments. Some employers even match the amount that you’re contributing to your fund.
Over time, enough money will accumulate in the 401(k) so that you’re able to live off those funds once you retire. It’s possible to take money out early from that account in the form of a low-interest loan.
How Does A Personal Loan Work?
A personal loan is a predetermined amount of money that can easily be sourced online or from a bank. They’re typically unsecured and come with a fixed interest rate that’s considerably lower than any credit card.
For a borrower with good credit, APR can be as low as 4%.
401(k) Borrowing Pros And Cons
The obvious drawback when borrowing from your retirement fund is that you’re in essence borrowing against your future self. You’ll be depleting retirement funds that’ll be necessary for your later years.
When done for sensible reasons, taking out a short-term 401(k) loan and repaying it on schedule can be a practical option.
Let’s look at the positives:
- Approval is likely and requires a straightforward application process
- No credit check is needed. Furthermore, missed payments aren’t reported to credit bureaus
- Interest rates are generally very low. The best part is that the interest goes back into your plan. Essentially, you’re paying interest to yourself
Keep in mind these drawbacks:
- A diminished retirement fund
- A requirement to pay a 10% early withdrawal penalty if taken out before the age of 60
Personal Loans Pros And Cons
Personal loans are an increasingly popular way to secure money to help fund a life event or deal with an unexpected emergency.
There are several reasons why they’re so popular.
When comparing a personal loan against 401k, here are its main advantages:
- These loans are unsecured. This means no collateral is placed against your loan so a lender can’t repossess your property or car
- They have fixed interest rates and a fixed repayment period
- Rates are generally low, though this does depend on your credit history
- In a crowded marketplace, it’s possible to shop around for the best deal
- By taking this type of loan out, your retirement fund will remain intact
Still, there are downsides including:
- Many come with an origination fee
- You may be charged a fee if it’s repaid before the agreed term
- A healthy credit score matters