If you are trying to decide between a 401k loan and a personal line of credit, you will need to weigh the pros and cons of both types of loans. A 401k loan is more accessible than a unique line of credit, and most have a 60 to a 90-day grace period, and it also comes with a lower interest rate. Here's how to make a decision:
A 401k loan is easier to get than a personal loan.
While a 401(k) loan may not be as easy to get as a personal one, it is still far more convenient. Not only can you borrow the money without worrying about late fees or high interest, but it will also go back into your retirement plan post-tax. While you have to pay interest on the loan, it is generally much lower than the interest you would pay elsewhere.
A 401(k) loan is easier to get than a personal one because it is not a traditional bank loan—however, there are a few things to remember before taking one out—first, the interest rate. While a 401(k) loan is less expensive than a personal loan, it does come with some pitfalls. For example, if you fail to make repayments on your loan, the IRS can count the entire balance as a taxable distribution, and you will have to pay a 10% early withdrawal penalty if you're under age 59.5.
Secondly, the loan terms. Personal loans usually allow borrowers to select the length of the loan, but 401(k) loans typically require five years to repay. 401(k) loans do not have prepayment penalties and allow multiple repayment options. Therefore, applying for a personal loan in a pinch is often easier. There are also fewer requirements, and the process is generally more straightforward and faster than applying for a 401(k) loan.
401k loan has a 60-90 day grace period.
One of the key differences between a 401(k) loan and a personal cash loan is that a taxable benefit cannot be withdrawn. Instead, you must repay the loan amount within 60 to 90 days. Your loan balance cannot exceed 50% of the account's value, ranging from $50,000 for charges up to $100,000. This is an excellent benefit for those who can't afford to pay off the total amount of the loan in one month.
In addition, a 401k loan requires that you repay the loan with post-tax funds. On the other hand, a personal loan requires you to pay taxes on the amount you borrow. You must also consider that you'll owe taxes again on your money if you fail to pay the 401k loan on time. Moreover, you'll be paying interest on this money for as long as the loan is outstanding.
The grace period is the second main difference between a 401k loan and a personal loan. Typically, a personal loan has a 60-day grace period, while a 401k loan requires a 90-day grace period. The longer the grace period, the better. Besides, a 401k loan comes with a 60-90 day grace period, so you can quickly pay it back without worrying about late fees and high-interest rates.
401k loan has a lower interest rate.
While a personal loan can be risky, a 401(k) loan can be a safer bet. Unlike a personal loan, the interest rate on a 401(k) loan is set by the plan administrator and is the same for all participants, regardless of credit score. While a 401(k) loan does carry an interest rate, it is much lower than the rate you'd pay on other types of loans.
A 401(k) loan offers the same interest rate as a personal loan, but you can deposit the difference into an after-tax savings account. In other words, a 401(k) loan is a good option when your investment yields less than seven per cent. You can use this money to invest in stocks, bonds, and real estate with higher interest rates. Alternatively, you can take out a bank loan to finance your retirement.
A 401(k) loan usually has a five-year term, but you can arrange for shorter times or pay the loan off early. The repayment period can be extended or shortened if you make regular payroll deductions. You're likely to have a longer repayment term for a home purchase, but if you're looking to limit the amount of interest you pay, you should pay it off faster.