Summary
- 401(k) Loans: Quick access, no credit checks, repayment via payroll, but risks retirement savings and requires full repayment if leaving the job.
- Home Equity Loans: Larger amounts, longer repayment, flexible usage, based on credit and income, with foreclosure as the main risk.
- Deciding Factor: 401(k) loans for immediate, smaller needs without credit concerns; home equity loans for larger, longer-term financing with stable financial standing.
While a 401(k) retirement account and a home can both be used as sources to borrow money, we generally recommend considering a home equity loan as it carries fewer personal financial risks. 401(k) accounts can be used to get money as many employers allow loans to be taken against the retirement savings account balance. If you own a home with sufficient equity, you can tap into it by applying for a home equity loan through a lender.
House Numbers can help you figure out the best way to access your home equity, all at no cost and with no impact on your credit score. If you’re considering either a 401(k) loan or a home equity loan for funding, continue reading as we’ll help you decide which is best for your circumstances.
Find the best way to unlock your home equity
House Numbers helps you access your home equity to pay off debt, fund home improvement, or general expenses.
Can you use funds for anything?
A 401(k) loan may have restrictions on what funds can be used for. This is often determined by your employer or the plan administrator. Commonly allowed uses of funds include medical expenses, a down payment on a home, tuition, debt consolidation, or other expenses due to a financial hardship.
Most home equity loans, on the other hand, allow funds to be used for nearly any purpose. This can include more discretionary items such as vacations, purchasing a new car, home improvements, and more.
Quick Comparison
| 401(k) loans | Home equity loans | |
|---|---|---|
| Typical Maximum Loan Amount | Lesser of $50,000 or 50% of the vested balance | $500,000, up to a 95% loan-to-value ratio |
| Typical Repayment Period | Up to 5 years (25 years for a home purchase) | Up to 30 years |
| Restrictions on Usage of Funds? | Yes | Typically no restrictions |
| Typical Interest Rate | Prime+ | Prime+ |
| Typical Credit Score Required | None | 640 |
| Typical Funding Speed | 1 to 2 weeks | 30 to 45 days |
| Minimum Requirements for Income? | No | Yes |
Pros & Cons
401(k) loans
| Pros | Cons |
|---|---|
| Easier qualification requirements than a loan | Short repayment periods |
| Conveniently repay loan through paycheck deductions | Use of funds may be restricted |
| Interest is paid back to your own account rather than to a lender | Requires repayment in full if employment is terminated |
| Retirement contributions are reduced or eliminated during repayment period | |
| Loan amount is often restricted to the lesser of $50,000 or 50% of your vested balance |
Home equity loans
| Pros | Cons |
|---|---|
| Low interest rates | Typically takes between 30 and 45 days to get funding |
| Funds rarely have restrictions on allowed uses | Qualification requirements can be difficult to meet |
| Loan amount is issued based on ability to repay rather than your current retirement account balance | Risk of foreclosure if you default on loan payments |
Find the best way to unlock home equity
How does a 401(k) loan work?
The application process & qualification requirements
With a 401(k) loan, you’ll be borrowing against the balance of your retirement account. You’ll typically need to first contact your employer or your plan’s administrator to get the process started. However, paperwork is often very minimal as there aren’t any credit checks or income verifications required.
Loan terms, interest rates, and fees
According to the IRS, most plans allow you to withdraw up to $50,000 or 50% of your vested balance, whichever is less, with a repayment term of up to five years. Interest rates will typically be close to the current U.S. prime rate.
401(k) retirement plans usually charge early withdrawal penalties and fees for accessing the money before age 59 1/2. Exceptions can be granted, however, such as using funds for medical expenses, satisfying IRS debt, down payment requirements for a home purchase, tuition, and more.
Loan funding, use of loan proceeds, and repayment terms
401(k) loans can typically be funded within 1 to 2 weeks. Some 401(k) loans restrict the use of loan proceeds, so you must keep this in mind so as not to violate the terms of your loan. Repayments are often made through regular payroll deductions.
If you lose or quit your job while you still have an outstanding 401(k) loan, you would have until the next tax filing deadline to make payment in full. This should be an item of major consideration if you are concerned about potential layoffs, or expect to switch employers in the future.
How do home equity loans work?
The application process & qualification requirements
Many banks, credit unions, and online lenders offer home equity loans. You’ll need to be a homeowner with sufficient equity to qualify, with some lenders willing to lend up to a 95% loan-to-value ratio. You can calculate this ratio by taking the balance of all your mortgage loans on the property and dividing it by the home’s value.
As part of the application process, the lender will verify and review various aspects of your credit, income, assets, and property. You can learn more about what happens during this stage in our underwriting guide.
Loan terms, interest rates, and fees
The strength of your loan application will dictate not only whether you’ll be approved, but also the rates and terms you’ll be offered. In general, home equity loans can have long repayment periods of up to 30 years, with rates that are between 1% and 3% above the current U.S. prime rate. Loan fees are often 1% to 4% of the loan amount.
A home equity line of credit (HELOC) is another type of home equity loan that you can also apply for. It usually carries slightly different terms and rates, such as offering variable interest rates instead of fixed rates. One of the biggest differences with a home equity line of credit is that it gives you the ability to continuously draw funds on an as-needed basis up to its credit limit.
You can learn more in our comparison of HELOCs vs home equity loans.
Loan funding, use of loan proceeds, and repayment terms
Funding can take between 30 and 45 days, and loan proceeds can be issued directly to you or your creditors if you’re paying off other debt. Unlike a 401(k) loan, you can use the funds for pretty much anything. For some ideas or examples, head over to our guide on what home equity loans can be used for.
Repayments are often made monthly as an additional payment on top of any existing first mortgage loan you may have.
Who should choose a 401(k) loan?
Individuals who fall into any of the following scenarios may want to choose a 401(k) loan instead of a home equity loan:
- You’re not able to get approved for a home equity loan: A 401(k) loan has none of the typical credit or income requirements associated with traditional loans. As a result, it can be a good alternative if you’ve been turned down for other financing options, such as personal loans.
- You have good job stability: 401(k) loans require repayment by the next tax filing deadline if you separate from your employer for any reason. Depending on the time of year, this may not give you much time to make payment in full.
- You have alternative sources of funding: Since a 401(k) plan requires repayment if you separate from your employer, it’s a good idea to have a means to repay loan proceeds in a worst-case scenario.
- You don’t anticipate a big impact on your long-term retirement savings goals: Borrowing against your retirement savings means you’ll no longer benefit from compound returns over the long run. We recommend seeking professional financial advice from a financial advisor to determine how big of an impact this could have on your long-term financial planning.
- You don’t want to pay loan interest: When you borrow money against your retirement savings, the interest paid doesn’t go to a financial institution. Instead, it goes back into your own account, so you’re essentially paying yourself back.
Who should choose home equity loans?
If any of the following scenarios apply to you, it may be worthwhile to consider getting a home equity loan instead of a 401(k) loan:
- You have good credit, income, and sufficient home equity: If you can qualify for a home equity loan, it’s usually a better option due to the drawbacks and restrictions associated with a 401(k) loan.
- You don’t need funds quickly: Home equity loans can take between 30 and 45 days to get. A 401(k) loan, on the other hand, can be funded within 1 to 2 weeks.
- You don’t mind using your home as collateral: If you default on a home equity loan, you risk losing your home in foreclosure. Make sure you can afford the payments, and see our tips on how you can avoid foreclosure proceedings.
- You have financial reserves: Due to the risk of losing your home in foreclosure if you default on the loan, it’s recommended to have some financial reserves to protect against setbacks such as a job loss or unexpected financial emergencies.
- You don’t want a setback in your long-term savings goals: Borrowing against your 401(k) takes away the advantage of long-term compound gains. Getting a home equity loan leaves those investments untouched.
Which type of loan should I get?
The decision to get a 401(k) loan or a home equity loan will depend on your personal financial circumstances, needs, and goals. In general, however, we recommend considering a home equity loan if you qualify.
401(k) loans have many downsides, are less flexible, and can be dangerous as they require full repayment within a short period of time if your employment is terminated. And while one of the biggest risks of getting a home equity loan is foreclosure, you typically have a much longer period to stop the process to retain possession and ownership of the property, making them more flexible and borrower-friendly.
