A 401(k) loan is one of the most significant benefits of a 401(k) plan. However, not every 401(k) plan lets you borrow money. The decision to approve the loans lies with the plan administrator and the employer and this is rare. Most employers provide their employees with this provision.

If your plan allows you the provision of a 401(k) loan and you wish to use it, you should dig deeper to know its benefits and drawbacks.

Some of the advantages and disadvantages of a 401(k) loan are:

Advantages

• The most significant advantage of a 401(k) loan is that you are borrowing money from yourself. This means you are both the lender and the borrower. Hence, you pay the principal amount and the interest to yourself. The best feature is that you are always repaying yourself instead of another party.
• The rate of interest in 401(k) loans is highly competitive. These rates are often found to be lower than various forms of debt, including credit cards or personal loans. Furthermore, the interest you pay on is tax-deferred. This means that the taxes are not due until the 401(k) plan is given to you after retirement.
• 401(k) loans usually do not have an application or processing fee that can add to your debt. However, it is wise to double-check if a payment is required for approval. Another advantage that this type of loan is unlikely to get rejected. While you do have to go through the application process, accessing your funds does not take much time.
• 401(k) loans have little to no restrictions. Approval for these loans does not require a credit check. Furthermore, the impact caused by a default in a 401(k) loan on your credit is significantly lower than traditional loans.

Disadvantages

• When you take this type of loan, you use up money that otherwise would be beneficial to you in the long-term. A 401(k) loan means that you miss an opportunity for potential growth. There is no denying that you earn interest when you lend money to yourself. However, it doesn’t make you much of a profit as the rate of interest is quite low.
• The second disadvantage is the risk of default. In case you lose or leave the job, most 401(k) plans require repayment within 60 days. After rebate, the loan that you previously took will be considered a distribution of funds on your 401(k) plan. This means that you are liable to pay taxes on the money received. Additionally, you may even have to pay a 10% penalty fee if you are below the age of 59 and a half years.In case you are laid off, you will have to choose between a sizable loan bill and a substantial tax bill. This is a significant possibility when taking a 401(k) loan.