401(k) Loan vs. Personal Loan for Debt Payoff

Borrowing from your 401(k) to pay off debt sounds appealing on paper. You’re borrowing from yourself, there’s no credit check, and the interest goes back into your own account. But the true cost of a 401(k) loan is almost always higher than it appears — and in many cases, a personal loan is the smarter choice even if the stated interest rate is higher.

Here’s why, with real numbers.

Quick Comparison

	401(k) Loan	Personal Loan
Interest rate	Prime rate + 1-2% (currently ~9.5-10.5%)	7-36% (depending on credit)
Maximum amount	$50,000 or 50% of vested balance (whichever is less)	Typically up to $50,000-$100,000
Term	Up to 5 years (15 years if for primary residence)	2-7 years
Credit check	No	Yes (hard pull)
Tax implications	Double taxation on interest; taxable distribution + 10% penalty if you default	Interest is not deductible; no tax penalty
Repayment	Payroll deduction (automatic)	Monthly payment to lender
What happens if you leave your job	Must repay in full by tax filing deadline or it becomes a taxable distribution	Nothing — loan terms don’t change
Impact on retirement	Missed investment growth during loan period	None
Credit impact	None — not reported to credit bureaus	Hard inquiry + new account on credit report

How a 401(k) Loan Works

Most 401(k) plans allow you to borrow from your vested balance. You can typically borrow up to $50,000 or 50% of your vested balance, whichever is smaller. If you have $60,000 vested, your maximum loan is $30,000. If you have $200,000 vested, your maximum is $50,000.

The interest rate is usually the prime rate plus 1-2%, which as of 2025-2026 puts it around 9.5-10.5%. You repay through automatic payroll deductions over up to 5 years. The interest you pay goes back into your own 401(k) account.

There’s no application process, no credit check, and no approval waiting period. If your plan allows loans, you can usually access the money within a few days.

Sounds great, right? Let’s look at what it actually costs.

The True Cost of a 401(k) Loan

The Opportunity Cost Problem

This is the cost most people completely overlook, and it’s usually the biggest one.

When you borrow from your 401(k), that money is no longer invested. It’s not growing. Over the long term, the stock market has returned an average of about 10% per year. When you pull $20,000 out of your 401(k) for 5 years, you’re missing out on the investment returns that money would have earned.

Here’s a concrete example:

Say you borrow $20,000 from your 401(k) at 9.5% interest for 5 years.

• Monthly payment: $420 (deducted from your paycheck)
• Total interest paid back to your account: $5,200
• Your 401(k) balance is made whole after 5 years: $20,000 principal + $5,200 interest = $25,200 returned

Looks fine. But here’s what would have happened if you’d left that $20,000 invested:

• At an average 10% annual return over 5 years, that $20,000 would have grown to roughly $32,200
• Instead, you have $25,200 back in your account
• The real cost: about $7,000 in missed growth

That $7,000 in lost growth is money your future self will never get back. And it doesn’t show up on any statement. It’s invisible — but it’s real.

At retirement, the impact is even larger. That $7,000 gap continues to compound. Over 20 more years at 10%, it becomes roughly $47,000 in lost retirement savings. From a single 5-year loan.

The Double Taxation Problem

When you contribute to a traditional 401(k), the money goes in pre-tax. You’ll pay taxes on it when you withdraw in retirement. That’s single taxation — the deal you signed up for.

But 401(k) loan interest is paid with after-tax dollars from your paycheck. Then, when you eventually withdraw that money in retirement, you’ll pay income tax on it again. The interest portion of your repayment gets taxed twice.

On a $20,000 loan, the $5,200 in interest gets double-taxed. If you’re in the 22% tax bracket, that’s roughly $1,144 in extra taxes over your lifetime. Not enormous, but it adds to the real cost.

The Job Loss Problem

This is the risk that makes financial planners wince. If you leave your job — whether you quit, get laid off, or get fired — the full remaining balance of your 401(k) loan is typically due by the tax filing deadline of the following year.

If you borrowed $20,000 and still owe $15,000 when you leave your job, you need to come up with $15,000 in a matter of months. If you can’t repay it, the outstanding balance is treated as a taxable distribution. That means:

• Income tax on $15,000 at your marginal rate (let’s say 22%) = $3,300
• 10% early withdrawal penalty if you’re under age 59.5 = $1,500
• Total tax hit: $4,800 — on money you were planning to repay

And you’ve permanently reduced your retirement savings by $15,000.

In a recession — when layoffs are most common — this creates a terrible chain reaction. You lose your job, can’t repay the loan, take a massive tax hit, and have less retirement savings, all at the same time.

How a Personal Loan Works

You apply through a bank, credit union, or online lender. If approved, you receive the funds and use them to pay off your debts. You repay in fixed monthly installments over 2-7 years.

Rates depend heavily on your credit score. With good credit (700+), expect 8-14%. With fair credit (580-669), expect 15-25%. With excellent credit (740+), some lenders offer rates as low as 6-7%.

Your job status has no effect on the loan terms. If you get laid off, your loan doesn’t become immediately due. The payment schedule stays the same.

When a 401(k) Loan Might Make Sense

There are limited situations where borrowing from your 401(k) is reasonable:

• You have very high-interest debt (25%+) and can’t qualify for a decent personal loan. If your credit is poor and you’re choosing between a 401(k) loan at 9.5% and a personal loan at 30%, the 401(k) loan costs less — even with the opportunity cost.
• You’ll repay it in 1-2 years, not the full 5. The shorter the loan period, the smaller the opportunity cost. If you can repay aggressively, the missed investment returns are minimized.
• Your job is very stable. If you work for a large employer, have strong job security, and have no plans to leave, the job-loss risk is lower (though never zero).
• You have no other options. If you’ve been declined for personal loans, don’t qualify for balance transfers, and have no other way to reduce high-interest debt, a 401(k) loan is still better than staying at 25%+ interest rates.

When a 401(k) Loan Is Almost Never Worth It

• You’re over 50 and approaching retirement. You have fewer years to recover the lost investment growth. Every dollar you pull out now has an outsized impact on your retirement balance.
• Your job situation is uncertain. If layoffs are happening in your industry, if you’re thinking about changing jobs, or if your company is struggling, the risk of the loan becoming a taxable distribution is too high.
• You have a history of re-accumulating debt. If you pay off credit cards and then use them again, you’ll end up with both new credit card debt and a depleted retirement account. At least with a personal loan, your retirement stays intact.
• The debt isn’t truly high-interest. If you’re consolidating debt at 12-15%, the opportunity cost of a 401(k) loan may actually make it more expensive than just paying down the debt aggressively.
• You can qualify for a personal loan at a reasonable rate. If you can get a personal loan at 10-12%, the total cost (including opportunity cost) is often comparable to or less than a 401(k) loan — without any of the job-loss risk.

The Full Cost: Side by Side

Let’s compare paying off $20,000 in credit card debt at 22% APR.

Option A: 401(k) loan at 9.5% for 5 years

• Monthly payment: $420
• Total interest: $5,200 (goes back to your account)
• Missed investment returns: ~$7,000
• Double taxation cost: ~$1,144
• Net real cost: ~$8,144 + job-loss risk
• Risk: Retirement savings depleted; taxable event if you leave your job

Option B: Personal loan at 11% for 5 years

• Monthly payment: $435
• Total interest: $6,060 (goes to the lender)
• Missed investment returns: $0
• Tax complications: None
• Net real cost: $6,060
• Risk: Credit impact only

The personal loan costs less in real terms, has no job-loss risk, and your retirement stays fully invested.

Frequently Asked Questions

Don’t I pay the 401(k) loan interest to myself?

Yes, the interest goes back into your 401(k). But this doesn’t make the loan free. The interest replaces investment returns that would have been higher. Paying yourself 9.5% interest sounds good until you realize your investments would have likely earned 10%+ over the same period. And the interest you pay with after-tax dollars gets taxed again at withdrawal.

Is a 401(k) hardship withdrawal better than a 401(k) loan?

Almost never. A hardship withdrawal is a permanent distribution. You pay full income tax plus a 10% penalty if you’re under 59.5, and you can’t put the money back. A 401(k) loan at least gets repaid. Hardship withdrawals should be an absolute last resort.

Can I borrow from my IRA instead?

No. IRAs don’t allow loans. You can do a 60-day rollover (withdraw and redeposit within 60 days), but this is risky and limited to once per 12-month period. Missing the 60-day window turns it into a taxable distribution with penalties. It’s not a practical debt payoff strategy.

What if my 401(k) plan doesn’t allow loans?

Not all plans do. Check with your plan administrator or HR department. If your plan doesn’t allow loans, a personal loan is your next best option for debt consolidation.

Bottom Line

A 401(k) loan is not the “free money” it appears to be. The opportunity cost of missed investment returns, the double taxation on interest, and the catastrophic risk of job loss make it more expensive than most people realize.

Choose a personal loan if you can qualify for a reasonable rate. Your retirement savings keep growing, your job status doesn’t affect the loan, and the true total cost is often lower.

Consider a 401(k) loan only as a last resort — when you have very high-interest debt, can’t qualify for other options, have strong job security, and will repay it as quickly as possible.

Your future retired self will thank you for leaving that 401(k) alone.