When you borrow money from your 401(k), you're essentially your own lender. The loan terms are attractive. There's no credit check. You get a low interest rate — which you pay to yourself — and repay the loan within five years. And unlike with 401(k) withdrawals, you won't be subject to additional income taxes and early withdrawal penalties.
All this makes 401(k) loans appear like a viable option when you're experiencing a financial emergency or looking to fund an important goal. However, it's wise to learn about the risks before you apply. CNBC Select explains how you can take out a loan from your retirement account and what you should keep in mind before taking this step.
What you should know about 401(k) loans
- How to take out a loan from your 401(k)
- What to consider before borrowing from your 401(k)
- Alternatives to a 401(k) loan
- Bottom line
How to take out a loan from your 401(k)
With a 401(k) loan, you can borrow money from your workplace retirement account and pay it back with interest. Both the balance payments and interest go back into your 401(k) account. The rate can fluctuate and is typically one or two points higher than the prime rate. For example, if the prime rate is 7%, you can expect to pay an 8% or 9% interest rate on your 401(k) loan.
To take out a loan, you'll first need to check if your plan even allows it. If so, you can request a loan from your plan administrator. According to Fidelity, you can borrow as much as 50% of your retirement savings, up to a $50,000 maximum. The specific terms depend on your plan's rules. If your request is approved, you'll receive money from investments in the account that are sold to cover the loan amount.
In most cases, you'll have five years to pay back the loan, provided you stay with the employer who sponsors the 401(k). If you leave your job before repaying the full balance, you'll likely have a very short period to finish repayment.
What to consider before borrowing from your 401(k)
Consider the following pros and cons when deciding whether borrowing from your retirement account is the right choice.
Advantages of 401(k) loans
- No credit checks. A low credit score won't result in a rejected application. Moreover, a 401(k) loan won't affect your credit at all — even if you default on it.
- Low interest rates. You'll pay a modest interest rate and this money goes straight into your retirement account.
- No taxes or fees (if you pay it back). With a loan, you won't have to pay taxes or penalty fees like you will if you withdraw the money.
Risks of 401(k) loans
- Taxes and fees (if you default). If you fail to repay your 401(k) loan as agreed and you're under 59½, you'll owe taxes and a 10% penalty.
- A loan tied to your employer. Because a 401(k) is an employer-sponsored account, things get complicated if you leave (or are asked to leave) your job — you'll have to repay the full amount of your loan before the due date of your federal income tax return.
- Derailing your retirement savings. Your retirement savings are crucial to your financial stability in the future. If you take out a loan against them, you'll probably miss out on their potential growth — which could total to more than the amount you'd repay yourself in interest.
Alternatives to a 401(k) loan
A 401(k) loan might be worth considering if you have a massive emergency expense but don't have enough in savings. It's also an option for debt consolidation if you have high-interest credit card debt. Still, it's wise to explore alternatives before you borrow against such a vital asset as your retirement funds.
Get a 0% APR credit card
If your credit is in good shape, you could qualify for a 0% APR credit card. This type of card allows you to avoid interest charges on new purchases for a specified period. The best 0% APR cards can give you longer than a year with no interest. For example, the Wells Fargo Reflect® Card offers 0% intro APR for 21 months from account opening on purchases and qualifying balance transfers (18.24%, 24.74% or 29.99% variable APR thereafter). Or look into a rewards credit card such as the Capital One SavorOne Cash Rewards Credit Card which comes with a 0% intro APR on purchases and balance transfers for 15 months (19.99% to 29.99% variable APR thereafter).
Wells Fargo Reflect® Card
On Wells Fargo's secure site
Rewards
None
Welcome bonus
None
Annual fee
$0
Intro APR
0% intro APR for 21 months from account opening on purchases and qualifying balance transfers.
Regular APR
18.24%, 24.74%, or 29.99% Variable APR
Balance transfer fee
5%, min: $5
Foreign transaction fee
3%
Credit needed
Excellent/Good
Capital One SavorOne Cash Rewards Credit Card
Learn More
Rewards
Earn 8% cash back on Capital One Entertainment purchases, earn unlimited 5% cash back on hotels and rental cars booked through Capital One Travel; Terms apply, 3% cash backon dining and at grocery stores (excluding superstores like Walmart® and Target®), 3% cash backon popular streaming services and entertainment, and 1% cash back on all other purchases
Welcome bonus
Earn a one-time $200 cash bonus after you spend $500 on purchases within the first 3 months from account opening
Annual fee
$0
Intro APR
0% intro APR on purchases and balance transfers for 15 months
Regular APR
19.99% - 29.99% variable
Balance transfer fee
3% for the first 15 months; 4% at a promotional APR that Capital One may offer you at any other time
Foreign transaction fee
None
Credit needed
Excellent/Good
Terms apply.
Read our Capital One SavorOne Cash Rewards Credit Card review.
Remember that while a 0% APR card can be excellent for interest savings, you only want to use it if you have a solid plan to repay the balance before the zero-interest period expires. Otherwise, you'll be hit with expensive interest charges.
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Take out a personal loan
If you need to borrow a large sum that will take a couple of years to pay off, a traditional personal loan can be helpful. You'll have a consistent monthly payment over several years, as well as a fixed interest rate. You'll likely pay more interest to a lender than you would yourself with a 401(k) loan — but you'll also avoid the risks that come with taking money from your retirement account.
Plus, it's possible to get a personal loan even with bad credit. CNBC Select recommends OneMain Financial which offers flexible terms and loan amounts. Avant is also a great choice if you need quick funding — borrowers can receive the money as soon as the next day after applying.
OneMain Financial Personal Loans
Annual Percentage Rate (APR)
18.00% to 35.99%
Loan purpose
Debt consolidation, major expenses, emergency costs
Loan amounts
$1,500 to $20,000
Terms
24 - 60 Months
Credit needed
Poor/Fair
Origination fee
Origination fee starting at $25 to $500 or percentage ranging from 1% to 10% (depends on your state)
Early payoff penalty
None
Late fee
Up to $30 per late payment or up to 15% (depends on your state)
Terms apply.* Click hereto see if you prequalify for a personal loan offer.
*You must complete a loan application and continue to meet any criteria used to select you for a loan offer. Not all applicants are approved.Loan approval and actual loan terms depend on applicant's state of residence and ability to meet OneMain Financial credit standards such as a responsible credit history, sufficient income after monthly expenses, and if applicable, availability of eligible collateral.
Not all approved applicants qualify for larger loan amounts, lower APRs, or the most favorable loan terms.For example, larger loan amounts typically require a first lien on a motor vehicle that is no more than ten years old, meets our value requirements, and is titled in applicant's name with valid insurance. APRs are generally higher on loans not secured by a vehicle.
Example Loan:A $6,000 loan with a 24.99% APR that is repayable in 60 monthly installments would have monthly payments of $176.07.
OneMain charges origination fees allowed by law.Depending on the state where the loan is opened, the origination fee may be either a flat amount or a percentage of the loan amount. Flat fees vary by state, ranging from $25 to $500. Percentage-based fees vary by state, ranging from 1% to 10% of the loan amount subject to certain state limits on the fee amount.
For information about these fees and minimum and maximum loan sizes available in certain states, visitomf.com/loanfees.
Current OneMain Customers:Loan offers presented to a consumer assume the individual has no active loan with OneMain or one of its affiliates. If a customer applies for a new loan offer, a OneMain representative will discuss available options.
Active-duty military, their spouse or dependents covered by the Military Lending Act (MLA) may not pledge any vehicle as collateral.If you are covered by the MLA, you are not eligible for secured loans.Loan proceeds cannot be used for postsecondary educational expenses as defined by the CFPB's Regulation Z such as college, university or vocational expense; for any business or commercial purpose; to purchase cryptocurrency assets, securities, derivatives or other speculative investments; or for gambling or illegal purposes. Time to Fund Loans:Funding within one hour after loan closing through SpeedFunds® must be disbursed to a bank-issued debit card. Disbursem*nt by check or ACH may take up to 1-2 business days after closing.
Avant Personal Loans
Annual Percentage Rate (APR)
9.95% to 35.99%
Loan purpose
Debt consolidation, major expenses, emergency costs, home improvements
Loan amounts
$2,000 to $35,000
Terms
24 to 60 months
Credit needed
Poor/Fair
Origination fee
Administration fee up to 9.99%
Early payoff penalty
None
Late fee
Up to $25 per late payment after 10-day grace period
Terms apply.
Click here to see if you prequalify for a personal loan offer.
Bottom line
In a financial crunch, a 401(k) can make sense, allowing you to avoid riskier financing sources such as payday lenders. At the same time, be careful pulling money from such an important investment vehicle. If you can obtain cash without putting your assets at risk, you might want to do just that.
Why trust CNBC Select?
At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every loan guide is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of loan products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.
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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.