What is the Difference Between a Personal Loan and a 401(k) Loan?

Features of a personal loan

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

• Fixed interest rate and set regular monthly payment
• Flexible repayment terms — meaning, there are multiple timelines you might choose from to pay back the money you borrow.
• Flexibility to use the money for a variety of major expenses or to consolidate debt
• Fast decision, often within a couple of business days, if not sooner. For example, Discover® Personal Loans offers same-day decisions in most cases.

Some things to know about personal loans:

• Because a personal loan is unsecured, 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; there are appropriate loan products that are specific  to those purchases.
• Check out our tips on how to apply for a personal loan for more information.

Features of a 401(k) loan

With a 401(k) loan, you’re borrowing from your 401(k) retirement account.

Some aspects of a 401(k) loan that borrowers may find compelling include:¹

• Convenience and speed of getting money for short-term cash needs – you may be able to borrow without a credit check.
• The interest you pay often 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, the IRS notes some potential consequences you may want to weigh.²

• Defaulting on your loan could result in it being treated as an early withdrawal, resulting in potential taxes and penalties.
• If your employment ends before you’ve paid back the loan, you may still be required to pay the loan back in full.
• You could potentially miss out on gains and compounded interest from investments the money was in before the loan.

Review your 401(k) plan documents for specific information on your plan’s rules and penalties. Our article Cashing Out Your 401(k): What You Should Know has more information about withdrawing from a 401(k). Be sure to always consult a tax professional or your financial advisor before making any decisions about your 401(k).

The bottom line

A 401(k) is designed as a long-term savings and investment vehicle, not necessarily a lending product. Money withdrawn from your 401(k) account will not be earning interest, so your retirement savings might not grow at the same rate.

Using a personal loan to consolidate debt may save you money in interest on higher-rate debts which could help you manage your budget effectively or add to your savings. Or using a personal loan to cover an unexpected expense or major life event could be beneficial.

Of course, every person’s situation is different. Your outcome depends on your financial situation and personal finance goals.

Want to learn about how to get a personal loan?

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