Is it better to get a HELOC or 401(k) loan?
Trying to decide between a 401(k) loan vs HELOC? A HELOC is almost always better than a 401(k) loan. Both options let you borrow money “from yourself,” but they’re very different in practice.
A home equity line of credit (HELOC) borrows from your property value. By contrast, the money in your 401(k) is actively working for you by accruing interest over time. Cashing those funds out means a serious setback in your retirement savings.
As long as you can qualify for a HELOC, that’s likely to be your best option.
Verify your HELOC eligibility. Start hereIn this article (Skip to...)
What is a 401(k) loan?
A 401(k) loan is a type of loan that allows you to borrow money from your 401(k) retirement savings account. A 401(k) is a retirement plan typically offered by employers in the United States.
Each employer gets to set its program’s rules. Your employer and account provider may or may not allow loans and early withdrawals; for those that do, rules and loan terms can vary.
Verify your HELOC eligibility. Start hereHow do 401(k) loans work?
If your plan allows, you can borrow up to 50% of your vested 401(k) balance or $50,000, whichever is less. Some plans offer a minimum loan of $10,000, even if it exceeds 50% of the balance. Repayments, including interest, are made through payroll deductions, typically over five years, unless the loan is for a primary residence. Interest goes back into your 401(k), but if the loan isn’t repaid, the IRS may classify it as a taxable distribution, triggering income taxes and a 10% early withdrawal penalty.
Regardless of your employer’s rules, full repayment is required within five years, unless the loan is for a primary residence. At least one payment per quarter is mandatory, and missing payments may result in the IRS classifying the loan as a withdrawal with tax penalties. When comparing a 401(k) loan vs HELOC, weigh the risks of borrowing from retirement savings versus using home equity as collateral.
Pros and cons of 401(k) loans
If you’re debating a 401(k) loan vs HELOC, consider these key advantages of a 401(k) loan:
- Lower interest rates than most loans
- No credit checks or approval barriers
- No homeownership or equity required
When comparing a 401(k) loan or HELOC, it’s important to note that for most borrowers, the drawbacks of a 401(k) loan far outweigh the benefits.
- No employer or personal 401(k) contributions while the loan is active
- Potentially lower borrowing limits than a HELOC
- Higher monthly payments due to shorter repayment terms
- Less flexibility—funds come as a lump sum, unlike a HELOC’s revolving credit
- Interest on the full loan amount rather than just the outstanding balance
- Long-term retirement losses from missed investment growth
If you’re deciding whether to borrow from a HELOC or 401(k) loan, the latter may be an option when you have low equity or credit challenges. Otherwise, consider alternatives that won’t put your retirement savings at risk.
What is a HELOC?
A Home Equity Line of Credit (HELOC) is a type of loan that allows homeowners to access the equity in their homes. It can be used for various purposes, including debt consolidation and home improvement projects.
A HELOC provides a revolving line of credit, similar to a credit card, where borrowers can access funds as needed. Repayment terms vary by lender, and interest is only charged on the amount borrowed.
Verify your HELOC eligibility. Start hereHow do HELOCs work?
A HELOC is a second mortgage that lets you borrow against your home’s value. Your borrowing limit typically falls between 80% and 90% of your primary home loan, minus what you owe. Unlike a 401(k) loan, which has fixed repayment terms, a HELOC offers revolving credit—but missing payments could put your home at risk.
Most HELOCs have variable interest rates, meaning your payments can change over time. During the draw phase, you can borrow, repay, and borrow again, paying interest only on what you use. Once the repayment phase begins, borrowing stops, and you must pay off the balance. A HELOC gives you more flexibility than a 401(k) loan, which must be repaid within five years.
When deciding between a HELOC vs 401(k) loan, consider how much flexibility you need. A HELOC works well if you have home equity and want ongoing access to funds. But if you’d rather avoid using your home as collateral, a 401(k) loan may seem safer—though it could impact your retirement savings long-term.
Pros and cons of HELOCs
If you’re debating between a 401(k) loan vs HELOC, keep in mind that HELOCs provide multiple benefits for homeowners looking for versatile funding options:
- Flexibility to borrow only what you need, when you need it
- Potentially lower interest rates than other types of loans
- Interest may be tax-deductible if used for home improvements (consult a tax advisor)
- Longer repayment periods, often up to 20 years
- Access to a revolving line of credit during the draw period
When weighing a HELOC vs 401(k) loan, it’s crucial to understand that HELOCs also come with potential drawbacks that borrowers should carefully consider:
- Variable interest rates, which can increase over time
- Risk of foreclosure if you default on payments
- Reduces home equity
- May have closing costs and fees
- Draw period followed by repayment period, which can lead to payment shock
- Potential for overspending due to easy access to funds
Comparison: 401(k) loan vs HELOC vs home equity loan
When considering your borrowing options, it’s important to understand the key differences between a 401(k) loan vs home equity loan, as well as whether to borrow from a 401(k) or HELOC. The table below will help you make the best choice for your personal finances.
Compare your loan options. Start here| HELOC | 401(k) Loan | Home Equity Loan | ||
| Loan Limit | 80-85% of home value | $50,000 maximum | Typically, up to 85% of home value | |
| Repayment Term | 1-2- years | 5 years | 5-30 years | |
| Interest Rates | Slightly higher | Slightly lower | Slightly lower than HELOC | |
| Type of Payout | Reusable credit line | One-time lump sum | One-time lump sum | |
| Biggest Benefit | Borrow a large sum at a low rate; won't impact your retirement | May be available if you don't have enough equity for a HELOC | Fixed monthly payments | |
| Biggest Drawback | Risk of foreclosure if you can't make payments | Serious setback in your retirement savings | Risk of foreclosure if you can't make payments |
When to consider a 401(k) loan, HELOC, or home equity loan
When facing financial needs or pursuing goals like home improvements or debt consolidation, it’s crucial to understand your borrowing options. Let’s explore whether to borrow from a 401(k) or HELOC and compare 401(k) loans vs home equity loans to help you make an informed decision.
Check your HELOC eligibility. Start hereHELOC vs 401(k) loan
A HELOC is almost always better than a 401(k) loan for several reasons:
- You are not risking your future comfort and security during retirement
- You can take longer to repay your loan than with a 401(k) loan, making each monthly payment smaller
- The loan is flexible; you can borrow, repay, and reborrow at will during the HELOC draw period
- You pay interest only on your outstanding balance; if you borrow nothing, you pay nothing
- You may be able to fix your mortgage rate on some or all of your HELOC borrowing
- You’ll likely enjoy a lower interest rate compared with most other types of loans
Example: Sarah needs $40,000 for home renovations. Her options:
- HELOC: 8.5% variable rate, 10-year draw period, 20-year repayment period
- 401(k) loan: 9.5% fixed rate, 5-year repayment period
The HELOC offers Sarah more flexibility with a longer repayment term and doesn’t impact her retirement savings. However, it comes at a higher total interest cost of $76,893.60 over the loan term compared to $10,631.60 for the 401(k) loan over five years.
The choice between a 401(k) loan vs HELOC depends on whether Sarah prioritizes lower monthly payments and flexibility or minimizing total interest paid.
401(k) loan vs home equity loan
When deciding between a home equity loan or 401(k) loan, consider that while a 401(k) loan can seem attractive due to its ease of access, a home equity loan often provides more benefits:
- Home equity loans typically offer extended repayment periods.
- Interest on home equity loans may be tax-deductible when used for home improvements.
- Home equity loans usually come with fixed interest rates.
- Unlike 401(k) loans, home equity loans don’t impact your retirement savings.
Example: John needs $50,000 for debt consolidation. His options:
- Home equity loan: 8.5% fixed rate, 15-year term, $494 monthly payment
- 401(k) loan: 9.5% fixed rate, 5-year term, $1,049 monthly payment
Despite the higher interest rate, the home equity loan offers John lower monthly payments and doesn’t disrupt his retirement savings. However, the 401(k) loan is cheaper in terms of total interest paid, costing $12,940 in interest payments compared to $38,920 for the home equity loan.
Additional factors to consider
When considering whether to choose a 401(k) loan vs home equity loan, remember:
- HELOCs and home equity loans require homeownership and sufficient home equity.
- A good credit score (usually 680-700 or higher) is typically necessary.
- 401(k) loans should be a last resort, used only when other affordable options aren’t available.
- Consult a financial advisor to evaluate your specific situation and explore all loan options before making a decision.
While a 401(k) loan or HELOC can provide access to cash, a 401(k) loan may put retirement savings at risk, whereas home equity loans and HELOCs typically offer better borrowing terms. A 401(k) loan should only be a last resort when you urgently need funds for large expenses and have no affordable alternatives due to low credit or high existing debt.
If you must choose a 401(k) loan, borrow only what’s necessary and repay it quickly. This helps minimize retirement losses and allows you to restart contributions—especially if your employer offers matching.
HELOC or 401(k) loan? If neither works, try these alternatives
If you’re comparing a 401(k) loan vs HELOC or debating whether a HELOC or 401(k) withdrawal is the better option for your financial needs, there are alternative borrowing options to consider. Depending on your situation, one of these alternatives may help you secure funds without putting your retirement savings or home equity at risk.
Verify your HELOC eligibility. Start here- Cash-out refinance: This option allows you to replace your existing mortgage with a new loan for a higher amount. The difference between the new loan and your old mortgage is received as a lump sum cash payout. Cash-out refinancing can help you tap into home equity while potentially securing a lower interest rate and extending your repayment period. However, it comes with origination fees and closing costs and may reset the terms of your mortgage.
- Personal loans: Personal loans are unsecured and based on your creditworthiness and income rather than your home equity. Their fixed interest rates and predictable monthly payments make them a practical alternative when considering a home equity loan vs 401(k) loan. While personal loans may have higher interest rates than home equity options, they do not put your home at risk.
- Tapping into your IRA: If you have an Individual Retirement Account (IRA), some plans allow penalty-free withdrawals for specific purposes, such as a first-time home purchase or medical expenses. This can provide flexibility compared to borrowing from a 401(k) loan or HELOC, but early withdrawals can still impact your long-term retirement savings.
- Early withdrawals from a 401(k): Withdrawing funds from your 401(k) before retirement age (59 ½) can be an option, though it often comes with financial drawbacks. You may face income taxes on any gains and a 10% early withdrawal penalty. Additionally, these withdrawals are not tax-deductible and could significantly impact your retirement savings.
- Hardship distributions: If you’re experiencing an “immediate and heavy financial need,” you may qualify for a hardship distribution from your 401(k). Eligible expenses include medical bills, home purchases, tuition, preventing eviction or foreclosure, funeral costs, and emergency home repairs. Unlike a loan, hardship distributions do not require repayment, but not all financial difficulties qualify.
- Credit cards: Credit cards can cover smaller expenses, but they carry high interest rates. If you’re considering using credit cards for debt consolidation or home improvements, have a solid repayment plan to avoid excessive interest charges.
Before making any financial decisions, think carefully about your goals. Do you absolutely need the funds? Are you selecting the least costly option available? Understanding the trade-offs between a HELOC vs borrowing from a 401(k) can help you make a more informed decision.
FAQ: 401(k) loan vs HELOC
Review your borrowing options. Start hereChoosing between a 401(k) loan or HELOC depends on interest rates, repayment terms, and risk. A 401(k) loan avoids lender fees and repays your own account but can reduce retirement growth and trigger taxes if unpaid after leaving your job. A HELOC often offers lower rates and longer terms but uses your real estate as collateral, meaning missed payments could lead to foreclosure, and variable interest rates may increase costs over time. If you’re weighing a HELOC vs borrowing from a 401(k), consider whether you prefer lower interest with collateral or borrowing from retirement savings with potential penalties.
A home equity loan or 401(k) loan both provide lump sums but differ in risk and cost. A 401(k) loan avoids lender fees but can reduce retirement growth and trigger penalties if unpaid. A home equity loan has fixed rates and predictable payments but requires closing costs and puts your home at risk if you default. When comparing a home equity loan vs 401(k) loan, think about whether stable repayment terms or preserving retirement funds is more important for your financial planning.
A 401(k) loan is borrowed against your retirement savings, while a HELOC is borrowed against the market value of your. While the interest on a 401(k) loan is paid to your own account, interest on a HELOC is paid to the lender. If you fail to repay a 401(k) loan, it can be treated as a taxable distribution from your plan, while failure to repay a HELOC could lead to foreclosure on your home. When comparing HELOC vs borrowing from a 401(k), weigh these risks carefully.
With a 401(k) loan, if you don’t pay it back in time, it can be treated as a withdrawal and subject to income tax and potentially a 10% early withdrawal penalty. Interest paid on a HELOC, on the other hand, may be tax-deductible if the funds are used for qualifying home improvements. This distinction is important when choosing between a HELOC or 401(k) loan, especially if you’re considering the tax benefits of each option.
Consider the purpose of the loan, the repayment terms, the interest rates, and the potential impact on your long-term financial goals. A financial advisor can best determine if borrowing from home equity vs 401(k) loan is the right choice for you.
Yes, you can have both a 401(k) loan and a HELOC at the same time. However, doing so means managing multiple loan repayments, which could strain your budget. When considering whether to borrow from a 401(k) or home equity, be sure to evaluate the long-term financial impact of carrying both types of debt.
HELOC or borrow from 401(k): Your next steps
For HELOCs and home equity loans, the only way you can be sure you’re choosing the least costly option is to get quotes from multiple lenders. Then compare the annual percentage rates (APRs) you’re offered. APRs reflect the loan costs as well as the raw interest rate.
A mortgage lender can help you evaluate your options and compare costs to find the best loan type for you. They can also help you weigh the pros and cons of a 401(k) loan vs HELOC to determine which option might be more suitable for your financial situation. Ready to get started?
Time to make a move? Let us find the right mortgage for you
