Ask a Fool: Is a 401(k) Loan a Good Idea?

Depending on the circumstances, a 401(k) loan can be a valuable financial tool.

Matthew Frankel, CFP
Matthew Frankel, CFP
Mar 22, 2019 at 12:00PM
Investment Planning

Q: I have about $15,000 in credit card debt and I'm thinking about borrowing from my 401(k) to pay it off. Is this a good idea?

I'm not a fan of 401(k) loans in most cases. I generally believe that retirement savings should continue to be saved for retirement. However, extinguishing credit card debt is one big exception where it might make good financial sense. Here's a quick rundown of the pros and cons of this approach to paying off your credit cards.

First, the negatives. When you take a 401(k) loan, you pay yourself back with interest, but your money won't be invested until the loan is paid back. 401(k) loan interest rates are typically low (prime plus 1% is common), and you could potentially miss out on a few years of investment gains. Plus, many 401(k) loans have origination fees, which can be higher than you'd get from a standard personal loan.

On the positive side, because the 401(k) loan will likely have a low interest rate, it can translate into significant savings. The average credit card APR is about 18%, and a double-digit APR reduction could save you thousands of dollars on $15,000 in credit card debt.

I suggest taking some time and at least looking into your other options, specifically personal loans. You might be surprised at what you can find, as the market for these has really exploded in the past few years. If you can obtain a personal loan with an APR comparable to a 401(k) loan, that would be my preference. On the other hand, if a 401(k) loan is your cheapest way to borrow by a wide margin, it can certainly make sense.