You can tap into your retirement savings early by taking a 401(k) loan, which lets you avoid income taxes and early withdrawal penalties. These loans don’t require a credit check, and the 401k loan interest rate is typically lower than what you’d find with other types of financing. Plus, the interest paid goes back into your retirement account.
Using a 401(k) loan can offer fast financial support when you need it most, but there are potential long-term consequences. Before you borrow, make sure you understand how these loans work, the interest rate on 401k loan terms, and the financial risks involved.
What is a 401(k) loan?
A 401(k) loan allows you to borrow from your retirement account and repay the funds with interest over time, typically through automatic paycheck deductions. The repayment period usually spans up to five years.
These loans can be used for a wide range of expenses, such as:
- Medical bills
- Home improvements or repairs
- Debt consolidation
- Education-related costs like tuition or student housing
- Overdue rent, mortgage, or utility payments
- Down payment on a home
- Financial emergencies
You don’t need a lender to take out a 401(k) loan, as you’re borrowing your own money. Loan repayments, including interest, are returned to your account, not to a financial institution. However, if you leave your job before the loan is repaid, you may be required to pay back the remaining balance, often within 90 days of leaving your employer.
Failure to repay the balance within that time may result in the loan being treated as a withdrawal, triggering income tax and, if you’re under age 59½, a 10% early withdrawal penalty.
401(k) loan vs. 401(k) withdrawal
A 401(k) loan involves borrowing from your retirement savings with the plan to repay the loan, generally through payroll deductions. In contrast, a 401(k) withdrawal permanently removes funds from your account with no repayment required.
Withdrawals are typically subject to a 10% penalty if taken before age 59½, along with regular income tax. Exceptions may apply for specific situations like emergency personal needs, qualified births or adoptions, or certain medical expenses. Even in these cases, the withdrawn funds are still considered taxable income.
How does a 401(k) loan work?
A 401(k) loan lets you borrow money from your retirement savings under specific borrowing limits and repayment rules. While it can be a quick way to access cash, it’s important to understand the risks and how this decision could affect your long-term retirement goals.
Plan policies
401(k) loan policies vary by employer. Some companies allow multiple loans, while others permit only one at a time. Interest rates and repayment terms can differ, too. Review your employer’s loan policy to understand potential restrictions, such as how loans are handled during a leave of absence or when changing jobs.
Borrowing limits
You can borrow up to $50,000 or 50% of your vested 401(k) balance—whichever is less. If 50% of your vested balance is under $10,000, you may borrow up to $10,000. For example, with a $60,000 vested balance, you could borrow up to $30,000. If you already have a loan, your new borrowing amount must stay within this total limit, including any outstanding balance.
Loan interest and fees
Some plans charge setup fees, typically ranging from $50 to $100, along with potential application or annual maintenance fees. You’ll also pay interest on your loan, but the interest goes back into your retirement account. This makes a 401(k) loan unique, as the money paid stays within your savings plan.
Repayment terms
Most 401(k) loans must be repaid within five years, although loans used to purchase a primary residence may qualify for a longer term. Payments are typically deducted from your paycheck and must be made at least quarterly.
Changing jobs
You usually have up to 90 days to pay back the remaining sum if you quit your employment while a 401(k) loan is still due, whether on your own volition or not. If not, the remaining amount will be regarded as a distribution and subject to the appropriate taxation. There may be an additional 10% early withdrawal penalty if you are younger than 59½.
Effect on retirement growth
Borrowing from your 401(k) reduces the amount invested during the repayment period. This can result in lost market gains and compound interest. Some plans also pause contributions while a loan is active, which may mean missing out on employer matching funds and reducing your future savings potential.
Impact on credit
A 401(k) loan doesn’t require a credit check and won’t appear on your credit report. Even if unpaid, it won’t impact your credit score. This makes it a low-risk option in terms of credit history.
401(k) loans vs. personal loans
Unlike 401(k) loans, personal loans don’t affect retirement savings but do involve borrowing from a lender with interest and stricter qualification requirements. Personal loans may allow higher borrowing amounts and longer repayment terms, but often come with higher interest rates and require a good credit score.
What Is The Interest Rate On A 401(K) Loan?
The interest rate on a 401(k) loan is typically tied to the prime rate, with most plans charging an additional 1% to 2% above that benchmark. As of March 2025, the prime rate stands at 7.50%, which places the average 401(k) loan interest rate between 8.50% and 9.50%.
401(k) loans frequently have more affordable interest rates than other types of borrowing. The average annual percentage rate (APR) for a two-year personal loan is 12.32%, according to recent data from the Federal Reserve, although the average APR for credit cards is much higher at 21.47%. For many people looking for short-term finance, this makes taking out a loan from your 401(k) a lower-interest choice.
Pros and Cons of 401(k) loans
Taking a loan from your 401(k) retirement account can be a useful financial option in the short term, but it’s important to evaluate both the advantages and potential drawbacks before deciding. Here’s what to keep in mind.
Pros
- No credit check: Since you’re borrowing your own money, a 401(k) loan doesn’t require approval from a lender or a credit inquiry.
- No credit impact: The loan won’t show up on your credit report, and even if it’s not repaid, it won’t directly affect your credit score. However, tax consequences may apply.
- Lower interest rate: 401(k) loans generally have a lower interest rate than personal loans or credit cards, often just 1% to 2% above the current prime rate.
- Interest returns to your account: Unlike traditional loans, the interest paid goes back into your retirement plan, not to a third-party lender.
- No early withdrawal penalties: As long as the loan is repaid on schedule, you won’t owe early withdrawal penalties or income tax.
Cons
- Not always available: Some employers don’t offer 401(k) loans as part of their plan options.
- Borrowing limits: You can only borrow up to 50% of your vested 401(k) balance or a maximum of $50,000, whichever is less.
- Missed investment growth: As your loan is outstanding, the borrowed amount doesn’t earn investment returns, potentially reducing your long-term retirement savings.
- Possible fees: Some retirement plans charge origination, processing, or annual maintenance fees that increase the overall loan cost.
- Risk of taxable distribution: If the loan isn’t repaid or you leave your job before repayment, the unpaid amount is treated as a taxable withdrawal and may trigger a 10% early distribution penalty if you’re under age 59½.
- Spousal consent may be required: In some plans, especially those subject to ERISA, you might need your spouse’s written approval before borrowing.
How To Get A 401(K) Loan
Applying for a 401(k) loan involves several important steps. Here’s a simple guide to help you navigate the process while protecting your long-term retirement goals.
- Review your plan’s guidelines
Start by reading your 401(k)’s Summary Plan Description (SPD). This document outlines if your plan allows loans, along with key details like borrowing limits, repayment rules, associated fees, and the application process. - Decide how much to borrow
Figure out exactly how much money you need before applying. Keep in mind that borrowing too much can reduce your future retirement gains. Be sure to include any setup fees or administrative costs in your estimate. - Contact your plan administrator
Get in touch with your employer’s human resources department or plan administrator to confirm eligibility and understand the steps for requesting a loan. Use this opportunity to ask questions about repayment policies or job change implications. - Submit your application
Once you’re ready, apply for the loan as directed by your SPD or HR team. Many 401(k) providers offer online portals to complete the application, while others may require a manual paper form. - Understand the loan terms
Carefully read the loan agreement before finalizing your application. Pay attention to the interest rate, fees, repayment schedule, and what happens if you leave your job or can’t repay the full amount.
Should You Use A 401(K) Loan To Pay Off Credit Card Debt?
As a 401(k) loan typically offers lower interest rates compared to credit cards, using retirement savings to pay off debt comes with serious risks. Just because it’s an option doesn’t mean it’s the best financial move, especially if you’re struggling to manage existing debt.
401(k) funds are generally protected from creditors and bankruptcy proceedings, while credit card debt is unsecured and may be discharged in bankruptcy. If you use your retirement funds to pay off unsecured debt, you risk losing long-term retirement security for short-term relief.
How Long Does It Take For A 401(K) Loan To Be Approved?
The approval and funding process for a 401(k) loan is usually quick. In many cases, the loan can be processed and disbursed within a few business days, especially if your retirement plan offers online loan requests.
However, some plans may require additional processing time, meaning it could take up to a few weeks, or even a month, for the loan to be finalized and funded.
How Soon Can You Take Out A 401(K) Loan After Paying One Off?
The ability to take another 401(k) loan after repaying one depends entirely on your plan’s policy.
Some employers allow multiple loans at once, while others restrict you to one outstanding loan at a time. If only one loan is allowed, you may face a waiting period between loans that could range from a few days to several months.
Will My Employer Know If I Take A 401(K) Loan?
Yes, your employer will usually be involved in the loan process if your retirement plan is employer-sponsored. Requests for a 401(k) loan typically go through your HR department or plan administrator. Because the plan is managed through your workplace, the employer must be notified to facilitate the loan.
What Happens If You Have A 401(K) Loan And Change Jobs?
You’ll usually have to pay back the remaining amount as soon as possible, normally within 90 days, if you quit your job with an outstanding 401(k) debt. The loan will be considered a taxable dividend if it is not paid back in full within the allotted period. If you are under 59½, you may also be subject to an early withdrawal penalty of 10% in addition to income tax.
Who Gets The Interest On A 401(K) Loan?
Interest payments from a 401(k) loan are reinvested in your personal retirement account. You are also responsible for paying the interest because you are borrowing from yourself.
Even while this interest helps your account over time, it is still an additional expense that needs to be factored into your monthly repayments.
401(K) Loan Alternatives
Before borrowing from your retirement account, it’s worth checking other financing options that won’t impact your long-term savings. Here are several alternatives to a 401(k) loan that may suit your financial situation better.
Personal loan
A personal loan provides a lump sum that you repay over a set period, often with fixed monthly payments. Loan amounts can reach up to $50,000 or even $100,000, depending on the lender and your credit profile. Lenders will evaluate your income, credit score, existing debts, and loan purpose to determine eligibility and terms.
Compare the APR of the personal loan with your expected investment gains and the interest rate on a 401(k) loan. If the personal loan APR is lower than the combined cost of borrowing from your 401(k), it could be the more cost-effective option.
Home equity options
Homeowners may be able to access funding through a home equity loan or home equity line of credit (HELOC). A home equity loan typically features a fixed rate and predictable payments, while a HELOC offers variable rates and flexibility in borrowing.
These loans often come with lower interest rates than unsecured options. However, your home serves as collateral, so failure to repay could result in foreclosure. They’re generally best suited for large or ongoing expenses.
Roth IRA withdrawals
You can withdraw your Roth IRA contributions at any time without taxes or penalties. This can be a strategic option if you’re unable to manage loan payments. However, any withdrawn contributions are permanently removed from your retirement account, and early withdrawals of earnings before age 59½ may trigger taxes and a 10% penalty.
0% APR credit cards
For smaller, short-term expenses, a credit card with a 0% APR promotional period can be useful. These offers generally last 12 to 18 months, and some may extend up to 21 months. Pay off the balance before the intro period ends to avoid high interest rates. This option requires strong discipline to avoid carrying a balance past the offer expiration.
Temporarily reduce 401(k) contributions
Consider temporarily lowering your 401(k) contributions if you want to free up additional money without taking out a loan. During a period of financial hardship, this action can raise your take-home pay. you maintain your retirement goals, make sure you start contributing again as soon as you can.
Conclusion
You may assess if taking out a loan from your retirement plan is the best course of action by understanding how the interest rate on a 401(k) loan is calculated, which is normally 1% to 2% more than the prime rate. Even though 401(k) loans frequently have lower interest rates than credit cards or personal loans, it’s important to consider how they can affect your long-term retirement funds. Before taking out a loan, always evaluate your options and read the conditions of your plan. You may reconcile immediate necessities with long-term financial security by making an informed choice.
Faqs About What Is The Interest Rate On A 401k Loan
Q1. What is the interest rate on a 401(k) loan?
Ans: The interest rate on a 401(k) loan is typically set at 1% to 2% above the current prime rate. As of 2025, with a prime rate around 7.50%, most 401(k) loan rates fall between 8.50% and 9.50%, depending on your plan’s rules.
Q2. What is the average interest rate for a 401(k)?
Ans: On average, 401(k) loans carry an interest rate of about 1% to 2% above the prime rate. This makes them more affordable than many personal loans and credit cards, especially for borrowers with limited credit history.
Q3. What is the downside to taking a 401(k) loan?
Ans: The main drawbacks include reduced investment growth, potential fees, and the risk of your loan becoming taxable if not repaid. If you leave your job, you may be required to repay the loan quickly or face penalties and taxes on the remaining balance.
Q4. What is the smartest way to withdraw from a 401(k)?
Ans: The most strategic way to withdraw from a 401(k) is after age 59½ to avoid penalties. Use systematic withdrawals in retirement, consider Roth conversions for tax planning, and only take hardship withdrawals or loans if absolutely necessary.
Q5. Should I pay off my 401(k) loan early?
Ans: Paying off a 401(k) loan early can help you restore investment growth and reduce the risk of tax penalties if you change jobs. If you have extra cash and no higher-interest debt, early repayment may benefit your long-term savings.
Q6. Does a 401(k) loan count as debt?
Ans: Technically, a 401(k) loan doesn’t count as traditional debt because you’re borrowing from yourself. It doesn’t show up on your credit report and won’t impact your debt-to-income ratio for loan applications.
Q7. Is a 7% 401(k) return good?
Ans: Yes, a 7% annual return on a 401(k) is considered solid and aligns with historical market averages. Over time, this rate can generate substantial compound growth, especially with consistent contributions and employer matches.
Q8. What is the maximum 401(k) loan?
Ans: The IRS allows you to borrow up to $50,000 or 50% of your vested 401(k) balance, whichever is lower. If 50% of your balance is less than $10,000, some plans may permit you to borrow up to $10,000.
