401(k) Loan vs Personal Loan: Which Is Better for a House Down Payment?

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The challenge of assembling a down payment is one of the most common roadblocks to homeownership.

Those who struggle with this may explore borrowing money in order to fund the upfront costs of homebuying. Personal loans and 401(k) loans stand as two options to possibly consider.

But the differences between them can be vast. Choosing which is more beneficial for your situation means breaking down their terms and your personal preferences.

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What is a 401(k) loan?

To start, a 401(k) is an employee contribution retirement fund. Your employer runs your plan and it deducts contributions from your paychecks.

Each 401(k) plan has its own rules. So sometimes you get a say over what investments your account makes. And sometimes your employer will make its own contributions to your account, perhaps even matching yours, dollar for dollar. Your 401(k) account is protected from creditors if you file for bankruptcy.

Depending on your plan’s rules, you may be allowed to borrow from your account through a 401(k) loan. It’s a fast and easy way to access cash, and you repay the amount you borrow plus interest. Loan terms typically run five years and the payments often get taken straight from your paycheck.

401(k) loan pros and cons

Almost every financial adviser will warn against borrowing from your 401(k) account. Having said that, 401(k) loans do have some advantageous lending conditions.

401(k) loans are generally a last resort when you have no other loan choices or your approved options come with painful interest rates. But with this type of loan, you’re raiding your future financial security.

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What is a personal loan?

With a personal loan, you borrow a lump sum over a fixed period and repay it in equal monthly installments. When you opt for a fixed-rate loan, every installment is the same. If you choose a variable-rate one, they may go up and down a bit.

Nearly all personal loans are unsecured. That means you don’t have to put up your home, car or any other asset as security or collateral. With rare exception, the funding can be used for any purpose. Many borrowers put the money towards consolidating debt, emergency expenses, or major life events.

Personal loans usually come with terms between one and seven years.

Personal loan pros and cons

Personal loans are quick to set up and affordable. You’ll often pay little or nothing in setup costs. And interest rates are competitive with other forms of borrowing. Your credit score will largely determine your rate. But it’s likely to be way lower than the one you’ll get on a new credit card.

401(k) loan and personal loan snapshot

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Choosing between a 401(k) and personal loan

Although 401(k) loans tend to be a last resort for borrowers, they could make sense in some cases: Like for those who might not qualify for other loans, want a quick application process, and can make on-time payments so you don’t disturb your retirement savings. With a 401(k) loan you’re effectively borrowing from yourself at a low rate.

Personal loans are usually a better option. They may work better if you have strong credit and qualify for a comparatively lower interest rate or want more flexible terms without early repayment fees.

The bottom line

Making the right decision when borrowing money comes down to your credit history, personal finances, and your goals for the funds.

If you’re having trouble saving for a down payment, a loan could help. However, before going down that road, you should see if you qualify for down payment assistance in your state. And trying to raise your credit score can help get you approved for other loan types or lower interest rates.

Reach out to a local lender when you’re ready to take the next step toward homeownership.

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