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Learn About Personal Loans

Personal Loan vs. 401(k) Loan

personal loan vs 401k loan

The difference between a 401(k) loan and a personal loan is that a 401(k) loan comes out of your own retirement account, while a personal loan is something you get from a bank, credit union or other lender.

As many as a third of Americans have borrowed from their 401(k), and nearly 40 percent have used personal loans. They’re both commonly used options when you need capital relatively quickly.

Personal Loan Features

A personal loan is unsecured debt that typically comes with the following features:

  • Fixed interest rate (and monthly payment)
  • Flexible repayment terms – meaning, there are multiple timelines in which to pay back the money you borrow (e.g. 36-84 month loan terms)
  • Opportunity to use the money for a variety of major expenses
  • Fast decision, often within a couple business days, if not sooner. With Discover Personal Loans®, many receive a decision the same day they apply.
  • In the case Discover, loan specialists are available seven days a week to walk you through the process.

Some other factors to consider about personal loans:

  • As an unsecured loan, the interest rate may be higher than other types of loans such as a loan that requires collateral, like a home equity loan.
  • Personal loans are not typically used to purchase homes or cars, as other loan products that are specific to those purchases are often more appropriate.

Check out our tips on applying for a personal loan for more information.

401(k) Loan Features

Some aspects of some 401(k) loans that might compel people to take them out include:

  • Convenience and speed of getting money for short-term cash needs
  • The interest you pay could potentially goes back into your retirement plan
  • May be easier to get approved depending on the plan administrator

While a 401(k) loan may work for some people, there are some potential drawbacks:

  • Defaulting on your loan might mean it is treated as an early withdrawal, which could result in both taxes and penalties
  • If your employment ends before you’ve paid back the loan, you could potentially have to pay back the loan within a short amount of time
  • Potentially missing out on gains and compounded interest from investments the money was in before the loan

Borrowing Against Your Future?

Unfortunately, some people who take out 401(k) loans regret their decision. This may have to do with what some would call “borrowing against your future.”

A 401(k) is designed, after all, as a long-term savings and investment vehicle, not necessarily a lending product.

On the other hand, research has tied personal loans – along with home and auto – to improving quality of life.

Using a personal loan to consolidate debt can actually reduce interest payments and create a payment plan based on a fixed monthly amount. This certainty about the rate and amount you’re paying may give some people peace of mind.

Of course, every person’s situation is different and the outcome will likely depend on the rate you get, your ability to pay back the loan in a timely manner and your comfort level with the employer (401(k) loans) or lender (personal loans).

Want to learn more about the nuances of taking out a loan? Read our list of 10 things to remember when borrowing money.