401(k) Loans

What can 401k loans be used for?

If your employer allows 401(k) loans, you could be wondering what 401(k) loans can be used for. Find out how you can use the 401(k) loan.

3 min read

If you need money quickly-and there are no other options- you can tap into your 401(k). There are no credit checks involved, and you can get approved with poor credit. 401(k) plans allow participants to borrow against their retirement savings for various purposes, but the loan must be repaid promptly over the repayment period.

You can use a 401(k) loan for virtually anything. You can use the 401(k) loan to pay for college expenses such as tuition, books, room and board, etc. If you have medical bills that are not covered by insurance, you can tap into your 401(k) to pay off the pending medical expenses. You can also use a 401(k) to pay down payment for your home or cover the cost of buying a car.

Borrow from 401(k) to pay college

Most 401(k) plans allow participants to borrow from their 401(k) savings to pay college expenses either for themselves, their spouses, or their children. You can use the money to cover college expenses such as tuition, fees, books and stationery, room and board, etc.

A 401(k) loan can be an alternative to a student loan, and you will make principal and interest payments to your retirement account rather than to a bank.

Typically, you can borrow a maximum of $50,000 or half of your vested balance to pay college expenses during the four years of college. You can also take out multiple 401(k) loans as long as the total loan amount does not exceed the allowed limit.

You will have five years to repay the loan in full, as long as you remain an employee of the company. If you separate from your employer midway through the repayment period, the outstanding loan will become due immediately, or by the following year’s tax deadline.

Borrow from 401(k) to Pay Medical Expenses

If you have a medical bill that your insurance does not cover, and you are short of cash, you can borrow from your 401(k) to pay the medical bill. A 401(k) loan can come in handy, especially when you don’t plan to use credit to handle the medical expenses.

Typically, you do not have to give reasons for borrowing from your 401(k) since you are borrowing your own money. If you have accumulated a big nest egg, you can borrow a maximum of $50,000 to pay the medical expenses. You must pay back this amount plus interest through payroll deductions.

You can also take a hardship withdrawal to cover the medical expenses. You qualify to take a penalty-free hardship withdrawal if the unreimbursed medical bills exceed 7.5% of your AGI. The withdrawal must occur in the same year you incurred the medical bill, and the amount withdrawn must not exceed the amount needed to cover the medical bill.

Borrow from 401(k) Buy a House

If you are in the process of buying a home, you are allowed to borrow from your 401(k) to raise the required fund. Generally, you can take a 401(k) loan to cover the down payment of the home or pay the closing costs. You will have a longer payback period, usually longer than 5 years, to pay off the loan.

Taking a 401(k) loan won’t affect your chances of qualifying for a mortgage, since the plan loan is not technically a debt. It has no impact on your credit score, and it is not considered when calculating your debt-to-income.

However, if you want to finance the entire home purchase, a 401(k) loan may not be as attractive as taking a mortgage loan. A mortgage loan offers tax deductions for interest payments, which you do not get with a 401(k) plan. Also, taking out a big portion of your retirement money could impact your retirement progress negatively since the money taken out from your 401(k) will lose out on compound interest.

Borrow from 401(k) to Buy a Car

If you are planning to buy a car, and you have not saved enough money yet, you may consider borrowing from your 401(k) to cover the purchase cost of the vehicle. You can borrow up to $50,000 to cover part or the full cost of the car.

If the purchase price of the vehicle is above $50,000, you may have to come up with the rest of the funds out-of-pocket or by taking an auto loan. You can also use the 401(k) loan to pay the down payment for the car, and use an auto loan to pay the rest of the cost. However, if you decide to go with both types of loans, be sure that you can afford the loan payments and the interest costs.

Borrow from 401(k) to Pay Debt

If you are overwhelmed by high-interest loans such as credit card loans, you might consider tapping into your 401(k) to get the debt under control rather than risk default.

A 401(k) lets you borrow money against your retirement savings, and make loan payments over time. Typically, the interest rate charged on a 401(k) loan is mostly below 5%, which is far below the rate charged by credit card issuers. The principal and interest payments go back to your 401(k) rather than to a bank or other lender. Also, the 401(k) won’t show up on your credit report, and it won’t impact your credit scores.

However, borrowing a large sum of money from your 401(k) could affect your lifestyle in retirement. Until you pay back the back, the amount will miss out on any gains you could have had, and the savings will not grow through compounding.