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Four Differences Between 401k Loan And Personal Loan

401(k) loans are not true loans, so in 401k loan vs personal loan the main difference is that they do not involve a Lender OR an assessment of your credit history. They are most accurately described as the ability to access a portion of your own retirement plan money, generally up to $50,000 or 50% of assets, whichever is less on a Tax Exempt basis. You must then refund the money you accessed in accordance with rules designed to restore your 401(k) plan to approximately its original state as if the transaction had not taken place.

Speed and convenience

With most 401(k) plans, applying for a loan is quick and easy, requiring no time-consuming applications or credit checks. Typically, it does not generate an Inquiry representing your credit or have any impact on your credit score.

401k loan vs personal loan: Many 401(k)s allow loan requests to be made with a few clicks on a website, and you can have funds in your hands within days, in complete privacy. An innovation that is being adopted by some plans is a debit card, through which various loans can be made instantly in small amounts.

Refund Flexibility

Although regulations specify a five-year repayment amortization schedule, for most 401(k) loans, you can pay off the plan loan faster with no prepayment penalty. Most plans allow loan repayment to be conveniently made through payroll deductions using after-tax dollars, however, do not pretax those funding your plan.

Cost Advantage

There is no cost (except perhaps a modest loan origination or administration fee) to leverage your own 401(k) money for short-term liquidity needs. Here’s how it usually works:

You specify the investment account(s) you wish to borrow money from, and these investments settle over the period of the loan. Therefore, you lose any positive profit that would have been produced by these investments for a short period, and if the market is down, you are selling those investments cheaper than at other times. The advantage is that you also avoid further investment losses with this money.

The cost advantage is the equivalent of the interest rate charged on a comparable consumer loan minus any loss of investment earnings on the principal you borrowed.

Let’s say you can take out a personal bank loan or take a cash advance from a credit card at an interest rate of 8%. Your 401(k) portfolio is generating a 5% return. Your cost advantage for 401(k) plan loans would be 3% (8-5 = 3).

Retirement Savings Can Benefit

As you make loan payments to your 401(k) account, they are usually allocated back to your portfolio investments. You will pay the bill a little more than you borrowed from it, and the difference is called “interest.” The loan has no (i.e., neutral) impact on your Retirement. If any lost investment earnings match the in-ie of “interest” paid, the earnings opportunities are offset dollar for dollar by interest payments.

If the interest paid exceeds any loss of investment earnings, taking out a 401(k) loan can actually increase the progress of your retirement savings.