Consolidating Debt with a 401(k) Loan
What it is
A 401(k) loan lets you borrow money from your retirement account—usually up to 50% of your balance for up to five years, with a maximum of $50,000. These loans typically come with low interest rates, which make them attractive for consolidating credit card debt.
How it works
For 401(k) loans, your interest rate is usually the current prime rate plus 1%. Once you sign the appropriate paperwork with your employer or plan provider, you should have access to the funds within a few days. Repayment terms often last five years and, if you default, your unpaid balance becomes a taxable distribution.
Factors to consider
- Interest rates
- Risk of defaulting
- Retirement plan hit
Important to know
- If you lose or leave your job during the loan term, payment is due immediately or else you will owe distribution taxes and maybe even an early withdrawal fee.
- Lower interest rates
- Pay interest to own account
- No impact to credit score
- No credit check, quick access to funds
- Takes from retirement savings
- Risk paying penalties
- Will pay double the taxes
- Need to pay back faster if employment changes
Though 401(k) loans can come with lower interest rates and no credit checks, they put you at a high risk of paying unnecessary taxes and penalties, not to mention cutting into your retirement savings. Learn about other debt consolidation methods.
If you need the money fast for a short-term expense and can pay back the loan on time, borrowing from your 401(k) is fine. It can be especially effective for your retirement savings if you take out the loan while the stock market is weak. We would not recommend a 401(k) loan for debt consolidation, though.
Some other good credit card debt consolidation options include personal loans, balance transfer cards, and home equity loans.