Whether you’re just getting started, have hit a rough patch, or are planning for expansion and need some capital for your business, there are a lot of different options available. While there are a number of common loans, like personal loans, business loans, and loans from investors, you may not qualify or feel like those loans are the best choice for you.
So, if that’s the case, what options do you have? One lesser-known loan alternative is a 401(k) loan. Most 401(k) plans have a provision that allows participants to take out a loan, which may be a great option for you. Keep in mind, though, that while there are some great benefits, there are some risks to be aware of as well.
What is a 401(k) Loan?
If your 401(k) has a provision that allows you to take out a loan, you have the option to “borrow” the money you have invested into your 401(k). Although you are borrowing money from yourself, there are certain restrictions that apply to the loan. If you haven’t already taken a loan against your 401(k) and haven’t had an outstanding balance in the last year, you can borrow 50 percent of your vested investment, up to $10,000 if the vested amount is less than $10,000, or $50,000 maximum. The amount you will be allowed to borrow if you have had an outstanding balance on a previous 401(k) loan in the past year will vary depending on the outstanding balance.
As with any other loan, there are specific terms and conditions for repayment, which include that the money be paid back with interest. The interest rate may vary from loan to loan, so you should discuss those details with your 401(k) representative. Depending on what you use the money for, the amount of time allotted to pay back the loan will vary, but typically borrowers can expect to repay within a five-year period. Although there may be specific terms and conditions for repayment, there are typically no restrictions on what you can use the money for, making it a solid option as a business loan alternative.
What are the Benefits of a 401(k) Loan?
A 401(k) loan could be the best option for you if you find yourself unable to take out other loans and have no other capital options. 401(k) loans have a number of benefits:
- No minimum credit score requirement. Credit score requirements can be one of the biggest issues when it comes to getting approved for a loan. If you have a low credit score, even if it’s due to circumstances outside your control, getting a loan with a good interest rate, or even getting a loan in general, can be difficult. Because a 401(k) loan doesn’t require a minimum credit score, you almost automatically qualify.
- No loan application requirement. Because you don’t have to apply for a 401(k) loan, you can save yourself the time and hassle of shopping around before finding the right place to take out a loan, including the time spent waiting to hear back about whether or not you are approved.
- The loan is repaid automatically through paycheck deductions. Rather than having to remember to pay a bill each month, repayment for a 401(k) loan is automatically deducted from your paychecks. This makes payment simpler and a little less frustrating than other types of loans, since you don’t have to see the monthly balance pulled from your bank account.
What are the Drawbacks of a 401(k) Loan?
It’s important to understand all the terms and conditions before taking out the loan to ensure it’s something you can feasibly handle. A 401(k) loan should be considered very carefully. While there are a number of benefits associated with the loan, there can be some serious drawbacks and consequences as well:
- Your retirement nest egg is depleted and vulnerable. If you take out a loan from your 401(k) and aren’t able to pay it back or have an outstanding balance on the loan, you could be putting your retirement at risk, especially if your 401(k) is the only retirement savings plan you have invested in.
- The interest is subject to taxation, and you may have to pay fees. Although only the interest is subject to taxation, that interest and tax is extra money that could have been saved in the 401(k). Additionally, there are often fees associated with taking out any loan, including a 401(k) loan, and although the fees may be relatively small, they can add up if you’re already pressed for money.
- The market could shift between the loan and repayment. If the market is at a lowwhen you take out a 401(k) loan, but up as you repay the loan, you could be costing yourself extra money as you work toward buying back in at a higher rate. It also costs you the opportunity to earn interest on the full amount had it been in the 401(k) as the market improved.
Should You Consider a 401(k) Loan for Your Business?
When considering a 401(k) loan for your business, keep in mind the drawbacks. If it hurts your retirement, will it be worth it? If something goes wrong, will you be able to pay it back? If you feel as though it is the best option for you and the drawbacks are worth the risk, then contact your 401(k) representative for more information.
When taken out carefully, 401(k) loans can be a great alternative to other types of loans. Do you think a 401(k) loan is the best option for your business?
If you’re interested in learning more about 401(k) loans or other funding options, contact the team at Currency today!