How to Borrow From Your 401(k) and What It Costs You

You can borrow from your own 401(k) balance, but the loan comes with strict repayment rules and real financial risks

A 401(k) loan lets you borrow money from your own account balance and repay it through payroll deductions. The IRS allows this under specific conditions: you can borrow up to 50% of your vested balance, with a maximum of $50,000 (adjusted periodically). The loan must be repaid within five years, unless you use the money to buy a primary residence, in which case the repayment period can extend longer. You pay interest to yourself, not to a bank, which is the main appeal—but leaving your money borrowed means it stops growing, and if you leave your job, the loan becomes due much faster than five years.

The entire process is handled through your employer's plan. You cannot take a loan from an IRA, a Roth IRA, or a SEP-IRA—only from a 401(k), 403(b), or similar employer-sponsored plan that permits loans in its terms.

Key Takeaways

• You can borrow up to 50% of your vested 401(k) balance, with a $50,000 cap, and must repay within five years (or longer for a home purchase).
• Interest rates on 401(k) loans are set by your plan administrator and are typically lower than bank loans, but you pay interest to yourself, not a lender.
• If you leave your job, the full loan balance becomes due within a specific timeframe—usually 60 to 90 days—or it is treated as a withdrawal and taxed as income.
• Borrowed money stops earning investment returns while it sits as a loan, which can significantly reduce your retirement savings over time.
• Defaulting on a 401(k) loan triggers income tax on the unpaid balance plus a 10% early withdrawal penalty if you are under 59½.

How the borrowing process works

To take a 401(k) loan, you contact your plan administrator (usually your employer's benefits department or the third-party company that manages the plan). They will provide a loan application and tell you the current interest rate, which varies by plan but is typically the prime rate plus 1 to 2 percentage points. You specify the loan amount and the repayment term you want (up to five years for general use, longer for a home).

Once approved, the money is deposited into a bank account you designate, usually within a few business days. Your employer then deducts the loan payment from your paycheck each pay period. The payment covers both principal and interest. Your plan administrator tracks the loan balance and sends you statements showing how much you still owe.

What happens to your money while it is borrowed

When you borrow from your 401(k), that portion of your account is no longer invested in stocks, bonds, or funds. It sits as a loan receivable, earning only the interest rate you are paying back. If your investments would normally return 7% annually and your loan interest is 6%, you are losing 1 percentage point of growth on that money every year.

Over a five-year loan, this opportunity cost adds up. A $20,000 loan that you repay in five years means $20,000 that did not compound with the rest of your retirement savings. By the time you retire in 20 or 30 years, that lost growth can reduce your final balance by tens of thousands of dollars. This is why a 401(k) loan is most defensible for a genuine short-term need—a medical emergency, a down payment on a home, or paying off high-interest debt. For routine expenses or wants, the long-term cost to your retirement usually outweighs the benefit of a low interest rate.

What happens if you leave your job

This is the most dangerous part of a 401(k) loan. If you resign, are laid off, or are fired while you have an outstanding loan, the plan administrator will demand repayment of the full remaining balance. The timeframe is typically 60 to 90 days, though your plan documents specify the exact period.

If you repay the loan in full within that window, there are no tax consequences—you simply move money from your new employer's plan, a personal savings account, or another source to pay it off. But if you cannot repay it in time, the unpaid balance is treated as a taxable withdrawal. You owe income tax on that amount at your ordinary tax rate. If you are under 59½, you also owe a 10% early withdrawal penalty on top of the income tax. Example: You have a $15,000 loan outstanding and lose your job. You have 60 days to repay it. If you cannot, that $15,000 is added to your taxable income for the year. If you are in the 24% tax bracket and under 59½, you owe roughly $3,600 in taxes plus $1,500 in penalties—$5,100 total on money you already borrowed from yourself.

Interest rates and how they compare to other borrowing

Your plan administrator sets the interest rate, which is usually the prime rate (currently around 8.5%) plus 1 to 2 percentage points. This means a 401(k) loan rate is typically between 9.5% and 10.5%, though it varies by plan and changes as the prime rate moves.

For comparison, a personal bank loan might run 10% to 36% depending on your credit, a credit card cash advance is often 20% to 30%, and a home equity line of credit might be 8% to 12%. A 401(k) loan is usually cheaper than credit cards or personal loans, but not always cheaper than a home equity line of credit or a mortgage refinance. The key difference is that you pay the interest to yourself—it goes back into your 401(k) account as part of your repayment. But you still lose the investment growth on both the principal and the interest while the loan is outstanding, so the true cost is not just the interest rate but also the opportunity cost.

Repayment rules and what happens if you miss a payment

Your loan repayment is deducted from your paycheck automatically, so as long as you stay employed at the same company, you cannot miss a payment. If you change jobs, you must arrange to repay the loan through your new employer's plan (if it allows transfers), a personal bank account, or another method specified in your plan documents.

If you miss a payment or fail to repay the loan by the deadline, the unpaid balance is treated as a taxable withdrawal. You owe income tax on the full amount, plus the 10% early withdrawal penalty if you are under 59½. The IRS also considers a missed payment a default, which can trigger additional penalties and interest. Some plans allow you to extend the repayment period if you have a hardship, but this is not automatic and depends on your plan's terms. You must request it in writing and provide documentation of the hardship.

Alternatives to a 401(k) loan

Before borrowing from your 401(k), consider whether another option makes more sense. If you need money for a home purchase, a mortgage or home equity line of credit is usually cheaper and does not jeopardize your retirement savings. If you have high-interest debt, a personal loan or balance transfer might cost less over time than the opportunity cost of a 401(k) loan.

If you have an emergency fund, using that money and rebuilding it later is often better than borrowing from retirement. If you have access to a Roth IRA, you can withdraw contributions (not earnings) without tax or penalty at any time, which is more flexible than a 401(k) loan. A 401(k) loan makes the most sense when you need money short-term, have no other source, and are confident you will stay in your job long enough to repay it. If any of those conditions is uncertain, the risks usually outweigh the benefits.

Frequently Asked Questions

Can I borrow from my 401(k) if I am self-employed?

No. Only employer-sponsored plans like a 401(k), 403(b), or 457 allow loans. If you have a Solo 401(k) (a 401(k) for self-employed people), you can take a loan from it, but only if your plan documents permit loans. Many Solo 401(k)s do not. IRAs, SEP-IRAs, and SIMPLE IRAs do not allow loans under any circumstances.

What is the difference between a 401(k) loan and a hardship withdrawal?

A loan must be repaid; a hardship withdrawal does not. But a hardship withdrawal is taxed as income and subject to the 10% early withdrawal penalty if you are under 59½, making it much more expensive. A loan avoids immediate taxes but creates repayment obligations. A loan is usually the better choice if you can repay it.

If I repay my 401(k) loan early, do I save money?

You save on interest, but you do not recover the opportunity cost of the years the money was borrowed. Repaying early is still better than repaying on schedule (you pay less interest), but it does not undo the lost investment growth. The real savings come from not borrowing in the first place.

Can I borrow from my 401(k) while I am still working?

Yes. You can take a loan while employed and repay it through payroll deductions. The risk is if you leave your job before the loan is repaid—then the full balance becomes due quickly. Some plans allow you to keep repaying after you leave, but this is not standard.

Does a 401(k) loan show up on my credit report?

No. A 401(k) loan is not reported to credit bureaus and does not affect your credit score. This is one advantage over a personal bank loan. However, if you default and the unpaid balance is treated as a withdrawal, the tax consequences will show up on your tax return.