You can get a guaranteed loan instantly by borrowing money from your 401k plan and even if you have trouble paying it back, the loan won't show up on your credit report. This type of loan, however, is usually a poor idea, especially if want to build good credit. Technically, a 401k loan is not a "loan," but borrowing from yourself.
How 401k Loans Work
Some employers allow you to borrow against the savings from your 401k plan, sometimes subject to certain restrictions such as how much you can borrow and what purposes you can borrow for. Often, you're able to get a 401k loan more readily than a traditional bank loan and for lower interest rates as well. On the other hand, you will also lose whatever money you would have earned if the borrowed money had been invested in your 401k and you may end up making fewer new 401k contributions because you are using your funds paying off the loan.
No Credit Check
A 401k loan does not affect your credit because it does not entail a credit check. You already own this money and the lender--your employer--automatically approves this. Alternatively, this means you cannot gain positive history on your credit report by paying this back on time.
When you apply for a loan, the lender may specifically inquire about any 401k loans as part of the application process. This could hinder your ability to gain credit because it increases your debt obligation and reduces assets. Lenders usually weigh your debt-to-income (DTI) ratio as heavily as your credit score, and having a DTI ratio of more than 35 percent will probably prevent you from getting a loan.
A 401k can indirectly impact your finances and reduce your ability to pay other loans with opportunity costs. When you pay back a 401k, you have to factor in taxes. If you borrow $300, for instance, and have a 24 percent tax rate, you would need to earn just more than $394 to pay back that $300. Also, this diverts money away from an interest-bearing account, which dwindles your income during retirement.
Even if you default, the 401k loan will not show up on your credit report. Defaults, however, incur a 10 percent penalty on top of your income tax rate. It can also shake your financial psychology. Ideally, retirement money should stay in an account and remain untouched until you retire and need it for an emergency, not everyday purchases.
Russell Huebsch has written freelance articles covering a range of topics from basketball to politics in print and online publications. He graduated from Baylor University in 2009 with a Bachelor of Arts degree in political science.