401(k) Loan vs. Personal Loan — What’s the Difference?

What to know about personal loans

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

1. A fixed interest rate and a set regular monthly payment.
2. Flexible repayment terms giving you a choice of timelines to choose for paying back the money you borrow. 
3. The flexibility to use the money for a variety of major expenses including consolidating debt.
4. A fast decision, often within a couple of business days, if not sooner. For example, Discover® Personal Loans gives same-day decisions in most cases. 

Some other things to know about personal loans:

• Because a personal loan is unsecured, the interest rate may be higher than other types of loans that require collateral like a home equity loan.
• Personal loans aren’t typically used to buy homes or cars. There are other loans specific to those types of purchases. 

If you think a personal loan is right for you, check out our tips on how to apply for a personal loan.

Understanding the 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.
2. The interest you pay often goes back into your retirement plan.
3.  It 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 consider :     

• Defaulting on your 401(k) 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 401(k) 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: choosing between a 401(k) loan and a personal loan 

A 401(k) is a long-term savings and investment tool. While a 401(k) loan is not a traditional loan, you will earn interest as part of the loan, but it is important to note that this is interest you are paying on the loan to yourself. This means you may have earned a higher rate of return in a 401(k) investment versus the loan interest you pay yourself.  

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

Of course, every person has different needs. Your outcome will depend on your financial situation and goals.

Want to learn about how to get a Discover Personal Loan?

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The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover Bank or its affiliates.