Is it a Good Idea to Use a 401(k) Loan to Pay Off Your Credit Card Debt?

Exploring your debt relief options can lead you to the right solution for your credit card debt. 

A 401(k) is one possible option to consolidate and refinance credit card debt is a 401(k) loan if your plan offers loans. Loans from your 401(k) plan have several advantages. They’re fairly inexpensive and they’re easy to get. The interest, which is relatively low, is paid to you—not a lender. Let’s go through the risks and potential costs of taking out a 401(k) loan so that you can make a more informed decision. 

What Is a 401(k) Loan?

A 401(k) loan is made from the balance in your workplace retirement plan—usually a 401(k). As with any other loan, you have to pay the money back on a regular schedule over time, and you have to pay interest on the amount you've borrowed. 

Because 401(k) loans come from tax-advantaged retirement plans, you have to meet certain conditions if you want to avoid paying taxes and penalties on the money you take out. 

Not all 401(k) plans let participants borrow against their balances. Being able to even consider a 401(k) loan means:

• You have to participate in an employer-sponsored 401(k) plan

• Your plan has to let participants borrow against their account balance

Check with the person at your job who coordinates your 401(k) plan to find out if you're eligible to borrow against it. You might also have online access to the plan details known as the Summary Plan Description (SPD). This will tell you clearly if you can take out a loan.

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How Does a 401(k) Loan Work?

A 401(k) loan works like any other loan. You borrow a set amount, and then repay it over time.

Because a 401(k) plan offers tax advantages, the IRS sets the rules for how these plans operate. Employers must follow these rules, and they can also set their own conditions for how employees may use the plan. You’ll have to meet all of the IRS’s requirements as well as your employer’s.

Borrowing against your 401(k) balance isn’t the same as taking a distribution from that plan. 

A distribution is a withdrawal of money from your account. Distributions from tax-deferred retirement plans like 401(k) accounts are considered taxable income. You didn’t pay taxes on the money when you put it into your 401(k), so you pay the taxes when you take the money out.

Furthermore, if you take a distribution from your 401(k) before you’re 59 1/2, you’re typically subject to a 10% early distribution penalty. 

IRS rules allow participants to borrow the money in their 401(k) plans under certain conditions. If those conditions aren't met, the loan may be considered a distribution from the plan. That would trigger tax consequences and possible penalties.

How much can you borrow from a 401(k) plan?

One condition the IRS places on 401(k) loans is how much you can borrow.

You’re allowed to borrow the lesser of:

• 50% of your vested account balance

• $50,000

Let's say Jerry and Bobby participate in the same 401(k) plan. Jerry has a balance of $200,000 in the plan, and Bobby has $60,000.

Half of Jerry's balance is $100,000. That exceeds the $50,000 maximum, so the most Jerry can borrow is $50,000.

Half of Bobby's balance is $30,000. Since this is less than $50,000, the most he can borrow is $30,000.

The borrowing limits apply to the total of all outstanding 401(k) loans that you might have. 

Interest and repayment terms for 401(k) loans

The longest you can take to repay a 401(k) loan is five years. You or the plan administrator may opt for a shorter term than that, but it can't be longer.

Loans must be repaid with a series of substantially equal payments over the loan term. Those payments must include principal and interest, and must be made at least quarterly. 

All 401(k) loans must charge interest. Your plan administrator has some discretion over the interest rate. Rates for 401(k) loans are normally low, such as 1% to 2% over the prime interest rate. You are your own lender, so the interest is paid to your account. 

What Are the Rules for a 401(k) Loan?

Here are some other rules to know about 401(k) loans.

The 12-month rule for multiple loans

Your employer's plan may allow you to have more than one 401(k) loan at the same time—but that doesn’t change the amount you can borrow. The maximum you can borrow—50% of your balance or $50,000— applies to the total of all loans. 

If you’ve gotten one within the last 12 months, its highest balance during that 12-month lookback period is subtracted from the limit on what you can borrow. Here’s how that might work:

• Let’s say your borrowing limit is $50,000

• In January, you borrow $10,000

• You want to borrow again in November

• You’ve paid your balance down to $5,000

• Your borrowing limit for the second loan is $40,000 

Loan limits and exceptions for smaller accounts

Loans against your 401(k) balance are generally limited to 50% of the vested total or $50,000, whichever amount is lower. People who are just starting to build their 401(k) balances could be severely restricted in how much they can borrow. So people with smaller accounts have some exceptions. 

That 50% limit only applies when it results in a loan limit of $10,000 or more. If 50% of your vested 401(k) balance is less than $10,000, you may be able to borrow up to $10,000, even if that’s more than 50% of your balance—subject to the plan's rules and limits. If your plan allows, you may be able to borrow the entire balance.

Special provision for home purchases

Most 401(k) loans must be paid back within five years, but there’s an exception for people who are borrowing to buy a home. 

As long as the home will be the borrower's main residence, the repayment period can be more than five years. The employer sets the rules for borrowing to buy a home. 

Documentation requirements

A 401(k) loan is a formal arrangement. Your employer (aka the plan sponsor) must keep written or electronic records about the loan, including:

• Your loan application

• Notes on the review and approval process

• A signed loan agreement

• Proof you’re using the loan to buy a home, if that changes the standard repayment terms 

• Loan payments

• Collection attempts for defaulted payments

Employer-specific restrictions

Employers can tighten the borrowing limits. For example, some plans may:

• Cap the amount you can borrow to less than the IRS limits

• Require spousal approval when a married participant takes a plan loan

• Suspend payments for employees in military service

• Suspend payments for up to one year during an unpaid leave of absence

One loan provision covers what happens if you leave your job, whether voluntarily or involuntarily. When you leave your job and have an outstanding 401(k) loan, this may change the normal repayment period. In the case of separation from your employer, it’s typical for most employers to require an immediate repayment of the loan balance. Sometimes there’s a short grace period. If you can't repay the loan, the money is considered a withdrawal. In that case, the withdrawal is treated as taxable income. If you’re under 59 1/2, you’ll also have to pay a 10% early withdrawal penalty.

Pro tip: It’s your employer’s call whether or not the plan provides loans. Check out your Summary Plan Description (SPD) for more information on loan availability and rules.

How to Get a 401(k) Loan: Step-by-Step Guide

Take these steps to get a 401(k) loan.

Contact HR 

Ask your HR department or benefits coordinator if your company allows 401(k) loans. You can read the sections in the SPD to find out more about loan terms such as the repayment period and interest rate charged. You can also log into your retirement account online to start the loan application process.

Calculate how much you need

Review your finances and decide how much you need to borrow. Check whether the amount will work with the loan limits of your plan. Then, create a repayment budget to make sure you'll be able to afford the loan repayments. 

File your application

Fill out the loan application. If approved, review and sign the loan agreement. 

Receive the funds 

The timing to receive funds varies by employer, but usually it takes just a couple of weeks to process your request. You’ll then receive the loan funds, either by check or direct deposit into your bank account. Once you've received the money, begin making regular loan payments according to the schedule set in the loan agreement. Consider putting your payments on autopay so you don’t miss any. 

How a 401(k) Loan Differs From a Hardship Withdrawal

The IRS lets employers allow hardship withdrawals from their plans—withdrawals made before normal retirement age because of immediate and heavy financial need. Examples include:

• Urgent medical care

• Funeral expenses for the spouse, children, dependents, or beneficiaries

• Payments to prevent eviction or foreclosure

Your plan administrator can tell you whether you qualify for a hardship withdrawal. The IRS doesn’t consider paying off credit card debt a valid reason for hardship withdrawals, so you might not qualify for one if that's why you need the money. However, you might if the debt was incurred due to a qualifying hardship.

If you do qualify, hardship withdrawals are considered taxable distributions. You might also have to pay a 10% early distribution penalty. We’ll go through some exceptions to the 10% penalty later on. 

A loan might be preferable to a hardship withdrawal if it allows you to avoid tax consequences. Also, with a loan, you can put the money back into your retirement plan on top of making regular contributions to the plan. 

A hardship withdrawal can’t be repaid. That means it will permanently set your retirement savings back.

When can you withdraw without penalties?

If you're in a tight financial spot, you may need money that you won't be able to repay within the required 401(k) loan term. In that case, you might consider simply withdrawing the money from your 401(k) plan.

The problem with this is that taking money out of the plan is likely to cost you, in the form of taxes and penalties. However, there are a number of exceptions.

You can take money out of a 401(k) plan before age 59 1/2 penalty-free if you:

• Have a qualifying disability 

• Take the distribution after you leave your employer and you’re over age 55

• Use the distributions to pay a spouse, former spouse, or dependent in qualified domestic relations order

• Need the money for a qualified medical expense 

• Sustained a loss due to a federally declared disaster, up to a limit of $22,000

• Are a victim of domestic abuse, up to a limit of $10,000 or 50% of the account, whichever is less

• Adopt a child or have a baby, up to a limit of $5,000 per child

• Pay for qualified higher education expenses

• Have personal or family emergency expenses, up to a limit of $1,000 per calendar year

• Have a terminal illness

Some of the exceptions here are for specific types of expenses, but you may be able to use the money to repay credit card debt incurred to pay those expenses.

Whether you’ll pay income tax on the money you withdraw depends on whether your plan is a traditional or a Roth 401(k).

In a traditional 401(k), you contribute money to the plan pre-tax, and you don't pay any taxes till you take the money out of the plan. If you’re contributing to a traditional 401(k) plan, the withdrawals will likely be subject to income taxes. 

A Roth 401(k) has a very different tax arrangement: you contribute money after you've already paid taxes on it. Withdrawals from a Roth 401(k) plan aren’t usually subject to income taxes unless. If you’re under 59 1/2, withdrawals may trigger the early withdrawal penalty unless it qualifies as one of the exceptions listed above. 

401(k) loan vs. 401(k) withdrawal side-by-side comparison

A loan and a withdrawal from your 401(k) could both have an impact on your long-term retirement savings as well as possible tax consequences. A withdrawal generally means paying a 10% penalty if you’re under 59 1/2. As long as you repay a 401(k) loan, there’s no penalty. However, the Secure 2.0 Act has a new provision for an emergency withdrawal, penalty-free, for immediate financial needs such as a family or personal emergency. Victims of domestic violence are also able to take a penalty-free $1,000 withdrawal. 

Here are the main differences between taking a 401(k) loan and a 401(k) withdrawal.

Why You Might Use a 401(k) Loan to Pay Off Credit Card Debt

A 401(k) loan could be useful for paying off credit card debt for a few reasons:

• No credit check required. A 401(k) loan could be an option even if you couldn't qualify for a traditional loan.

• 401(k) loans usually aren’t reported to credit bureaus, so the new debt won't affect your credit score.

• As you're borrowing the money from your own retirement savings, 401(k) loans can generally be processed faster than many traditional loans.

• Typically very low interest rates. 401(k) loans tend to be much cheaper than credit card debt. They’re also generally cheaper than the average personal loan. With a 401(k) loan that interest is paid into your own 401(k) account—not to a lender.

This last point is a top reason for refinancing credit card debt. Lowering your interest rate allows more of your payments to go toward debt pay-off rather than interest. This could help you get out of credit card debt faster.

401(k) Loan Costs

The costs of a 401(k) loan are different from those of a traditional loan, and those differences have pros and cons. Here are the two major types of costs.

Interest and fees

On the plus side, 401(k) loan interest is paid into your own 401(k) account, instead of to a lender.

The 401(k) plan administrator may charge a fee for initiating a loan. This is also true of many traditional loans.

Opportunity costs

A stark difference between a 401(k) loan and a traditional loan is the impact on your retirement savings. 

When you borrow from your 401(k) balance, that money is no longer invested. You'll miss out on market returns until you repay the money. The compounding effect of investment returns can magnify this opportunity cost. 

Also, repaying the loan could impact your ability to continue making contributions to the plan over the next few years. In that case, you'll miss out in two ways: on the potential investment returns on your money, as well as the tax advantage of those plan contributions.

The problem with these trade-offs is that you won’t know how much they'll cost until later. A big reason to borrow from your plan to pay off credit card debt is to save money by paying a lower interest rate. However, you can't know at the moment whether your investment returns would have been worth more or less than the credit card interest saved. 

When it comes to comparing costs, using a 401(k) loan to pay off credit card debt means making an educated guess. Unlike the costs of a conventional loan, the biggest cost of a 401(k) loan may be to your long-term retirement wealth, and that’s hard to calculate precisely.

Tax Costs of Using a 401(k) Loan to Pay Off Credit Card Debt

Taking out a 401(k) loan diminishes some of the tax advantages of participating in a retirement plan. It also brings the risk of an additional tax penalty.

In a traditional 401(k) plan, the money you put in hasn't been taxed. When you borrow against that money, you'll be paying it back with after-tax dollars from your paycheck. 

Then you'll pay taxes on withdrawals in retirement. 

You also face the risk of triggering income taxes plus a 10% early distribution penalty. This could happen in a couple of ways:

• If you don’t repay your loan within the time limit or you make too many late payments, the unpaid amount may be categorized as a distribution rather than a loan. That money would then be subject to ordinary income taxes. Also, if you're younger than 59 1/2, you'll be hit with an additional 10% early distribution penalty.

• If you leave your job for any reason, your employer can demand immediate repayment of the outstanding balance on your 401(k) loan. If you can't repay, it'll be considered a distribution. The amount you owe would be subject to income tax, and if you're younger than 59 1/2, you'd also face the 10% penalty. 

You can avoid some of these tax costs by repaying the loan on schedule. 

As with any loan, before you borrow it’s best to figure out a budget that will allow you to make the required payments comfortably. With a 401(k) loan, you also have to assess the likelihood that you'll remain with your employer throughout the loan term. 

Using a 401(k) Loan to Pay Off Credit Card Debt: Pros and Cons

Here’s a summary of some of the pros and cons of using a 401(k) loan to pay off credit card debt:

Does a 401(k) Loan Affect Your Credit Score?

A 401(k) loan shouldn't directly affect your credit score. However, depending on how you use one, a 401(k) loan could have an indirect impact on your credit score. 

A 401(k) loan doesn't directly affect your credit score because they don't require a credit check and they aren't reported to credit bureaus. However, a 401(k) loan could impact your finances in a way that does affect your credit score. Whether this is good or bad depends on how you use the loan.

If you use the 401(k) loan to pay down credit card debt, it might give your credit score a quick boost. That's because paying off your credit cards with a 401(k) loan will reduce the amount of revolving debt that shows up on your credit report.

However, if the burden of paying back the 401(k) loan causes you to struggle to make other payments, it could have a negative long-term effect on your finances. In particular, if you default on the 401(k) loan, the tax consequences and possible 10% early withdrawal penalty could hurt your ability to make other payments.

With a 401(k) loan, you’re borrowing from your own account balance. This makes you both borrower and creditor. Consider your ability to repay the loan as critically as a regular creditor would before you decide to proceed.

Alternatives to Using a 401(k) Loans to Pay Off Credit Card Debt

A 401(k) loan can be used as a debt consolidation loan to pay off credit card debt. There are also other forms of debt consolidation loans, as well as other debt relief alternatives.

Here are some alternatives to taking out a 401(k) loan to deal with your credit card debt.

Unsecured personal loan 

An unsecured personal loan doesn't require any collateral. You generally need a good credit score to qualify. The interest rate may not be as low as you’d get with a 401(k) loan, and you'd be paying interest to the lender rather than back into your own account. 

Something to consider: borrowing money from outside the account means you wouldn’t miss out on investment gains in your 401(k).

Secured personal loan

A secured personal loan requires collateral—something of value you pledge to the lender in case you default on the loan. This may help you qualify for a personal loan with a lower credit score. 

Home equity loan

If you’re a homeowner, a home equity loan lets you use the equity in your home as collateral to qualify for a loan and get a lower interest rate compared to many other kinds of loans. This depends on having enough equity to borrow against. Also, putting your home up as collateral makes it especially important to have a realistic plan for repaying the loan. 

Balance transfer credit card 

Balance transfer cards give you a temporary introductory period, often from 12 to 21 months, at zero or very low interest. You can transfer balances from other credit cards onto one of these cards to reduce interest during that introductory period. You’ll typically pay a 3% to 5% fee for each balance you transfer. It's key to have a plan to pay off the balance during the intro period. Otherwise, you'll be back to paying high credit card interest.

Loan from a friend or family member 

A close friend or family member may be able to lend you the money to pay off your debt. Much depends on your relationship with that person and their own finances. Think of this type of help like any other loan, with an interest rate and set repayment period, to preserve good relations. If the amount is more than $19,000 in 2025, it could be subject to the gift tax.

Emergency fund or other savings

After-tax savings could be a ready source of money to pay off credit card debt. This saves you the expense of paying credit card interest. It's smart to have a plan for rebuilding your emergency fund so you’ll have it to fall back on in the future. 

Debt management plan

A debt counselor at a nonprofit agency could help you manage your payments to pay off debt as efficiently as possible. The plan may include negotiating more favorable repayment terms, including fee waivers, lower rates, or more time to pay.

Debt settlement 

Debt settlement is a negotiated agreement with a creditor to reduce the amount you owe. You can either try DIY debt settlement or use a professional debt relief specialist.

Bankruptcy

If you've looked at the alternatives and can't find a realistic way to resolve your credit card debt, declaring bankruptcy might be your best shot at a financial reset.

The best solution to your credit card debt depends on your individual circumstances. These include your financial resources and your credit score. Consider which solutions are available to you in light of these circumstances. Then compare the costs of the available alternatives when making your decision.