401(k) Loan or Personal Loan — which one is truly more cost-effective? We compare them using not just interest rates but opportunity cost. Check below to see the full breakdown.
1️⃣ What Is a 401(k) Loan?
A 401(k) loan lets you borrow from your own retirement account — up to $50,000 or 50% of your vested balance, whichever is less. You typically repay within 5 years, or up to 15 years if the loan is for a home purchase.
Key features:
- No credit check
- Interest is paid back to your own 401(k) account
- Payroll deduction repayment
⚠️ Warning: If you leave your job before the loan is fully paid, you must repay the entire remaining balance within 60 days. If not, it's treated as a withdrawal and you may owe 10% penalty + income tax.
2️⃣ What Is a Personal Loan?
Personal loans come from banks or online lenders, not from your own retirement assets.
- Typical interest rates: 6–12%
- Requires credit approval
- Interest paid to the lender (not yourself)
✅ Benefit: Your 401(k) remains fully invested, continuing to grow.
3️⃣ The Real Comparison: Opportunity Cost
It's not just about interest rates. With a 401(k) loan, you're removing money from your investments, losing the chance for potential gains. That loss is your opportunity cost.
4️⃣ Example Comparison: $20,000 Loan with 9% Return Assumption
| Item | 401(k) Loan | Personal Loan |
|---|---|---|
| Loan Amount | $20,000 (from 401k) | $20,000 (external) |
| Interest Rate | 5% | 7% |
| Total Repayment | $21,000 | $21,400 |
| 401(k) Investment Return (9%) | Missed $1,800 | Full $1,800 gained |
| Net Financial Impact | $800 loss (opportunity cost - interest to self) | $1,400 loss (paid to lender) |
5️⃣ Summary Table
| Scenario | Best Option |
|---|---|
| High expected returns (> loan rate) | Personal Loan |
| Expected returns ≈ loan rate | 401(k) Loan |
| Conservative investor (low returns) | 401(k) Loan |
| Need fast and easy access | 401(k) Loan |
6️⃣ Visual Comparison: Cost vs. Return
[Expected Investment Return vs. Loan Cost]
| Category | Amount |
|---|---|
| 401(k) Potential Return (9%) | +$1,800 |
| 401(k) Loan Cost (5%) | -$1,000 |
| Personal Loan Cost (7%) | -$1,400 |
7️⃣ Conclusion
Choosing between a 401(k) loan and a personal loan isn't just about who charges less interest. It's about where your money is — growing in your retirement account, or being used for expenses.
- If your 401(k) is generating high returns, removing money hurts more than paying bank interest.
- If your investments are low-risk and low-return, the 401(k) loan might be cheaper overall.
Key takeaway: Always consider your expected return, job stability, and available loan terms before choosing.
