Advertiser Disclosure

College Students and Recent Grads, Life Events, Pay Down My Debt

What is a 401(k) Loan and How Does it Work?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

personal loan_lg

If you’re in need of money and your savings account balance is low, you may be tempted to use the handy little loan provision that most 401(k) plans offer. That’s right! You can probably borrow money from your 401(k). Right from your own account! It’s a nifty feature, but is it a good idea?

Today we’re going to start examining that question by diving into what exactly a 401(k) loan is and how it works. The next post in this series will look at a few situations in which borrowing from your 401(k) can work in your favor.

Let’s get into it!

Quick note: Every 401(k) plan has different terms and conditions and some plans don’t allow for loans at all. Consult your Summary Plan Description for specific details about how your plan handles loans.

What Is a 401(k) Loan?

When you borrow from your 401(k) you are actually borrowing money directly from yourself.

The loan is taken directly out of your 401(k) account balance. Then a repayment plan is created based on the amount you borrowed and the interest rate and those payments are made back into your 401(k) account, typically through an automatic payroll deduction.

In other words, you are borrowing from yourself and paying yourself back. Both the principal and the interest on the loan eventually make their way back into your 401(k).

How Much Can You Borrow?

Figuring out how much you can borrow from your 401(k) can be a little tricky, but here’s a quick summary.

If you haven’t had any outstanding 401(k) loan balance within the past 12 months, you are allowed to borrow the lesser of:

  • $50,000, or
  • 50% of your vested 401(k) balance. If that amount is less than $10,000 then you can borrow up to $10,000, but never more than your total account balance.

Sounds simple, right? But wait, there’s more…

If you have had an outstanding 401(k) balance within the past 12 months, the amount you’re allowed to borrow is reduced by the largest balance you had over that period.

Let’s look at a few examples:

  • Example #1: Joe has $25,000 in his 401(k) and has not had a 401(k) loan balance within the past 12 months. He is allowed to borrow up to $12,500.
  • Example #2: Theresa has $15,000 in her 401(k) and has not had a 401(k) loan balance within the past 12 months. She is allowed to borrow up to $10,000.
  • Example #3: Becca has $150,000 in her 401(k) and has not had a 401(k) loan balance within the past 12 months. She is allowed to borrow up to $50,000.
  • Example #4: Steve has $25,000 in his 401(k) and did have a 401(k) loan balance of $5,000 within the past 12 months. He is allowed to borrow up to $7,500.

What Is the Interest Rate?

Each 401(k) plan is allowed to set their own loan interest rate. You should consult your Summary Plan Description or ask your HR rep for details about your specific plan.

However, the most common interest rate is the prime rate plus 1%.

What Can the Money Be Used For?

In many cases there are no restrictions on how you use the money. It can be put to work however you want.

But some plans will only lend money for certain needs, such as education expenses, medical expenses, or a first-time home purchase.

How Long Do You Have to Pay the Loan Back?

Typically, your 401(k) loan must be paid back within 5 years. If the loan is used to help buy a house, the term may be extended up to 10-15 years.

The catch is that if your employment ends for any reason, the entire remaining loan balance is typically due within 60 days. If you aren’t able to pay it back within that time period, the loan defaults.

What Happens If You Default on the Loan?

A 401(k) loan defaults any time you aren’t able to comply with the terms of the loan. That could be failing to make your regular payments or failing to repay the remaining loan balance within 60 days of leaving the company.

When that happens, the remaining loan balance is counted as a distribution from your 401(k). That has two big consequences:

  1. Unless you’re already age 59.5 or meet other special criteria, that money will be taxed and hit with a 10% penalty.
  2. The defaulted amount is not eligible to be rolled over into an IRA or other employer retirement plan. So there’s no way to avoid the taxes and penalty.

The good news is that the default is not reported to the credit bureaus and therefore has no impact on your credit score. Though if you’re applying for a mortgage or other loan, the lenders may ask about any 401(k) loan defaults and factor that into their decision.

How Do You Apply for a 401(k) Loan?

And as long as you have a vested 401(k) balance, the process loan application process is typically pretty simple.

Other than adhering to any specific restrictions your plan may enforce (see above), it’s usually as easy as requesting the loan. That can often be done online or at worst with a little paperwork through your human resources department.

There is no credit check for 401(k) loans, which can make them easier to get than other types of loans. And loans must be available to all employees, so you should be able to get approved no matter what your position is in the company.

Other Considerations

Here are a few other things to consider as you weigh the pros and cons of taking out a 401(k) loan:

  • Other than the possibility of default, the biggest potential cost is the missed investment returns while the money is out of your 401(k). Depending on the size of the loan and the market returns during the life of the loan, that could be significant.
  • Your spouse often has to sign off on the loan.
  • You can have more than one 401(k) loan out at a time, but the total loan balance can’t exceed the limits described above.
  • There may be a fee involved with taking out the loan.
  • Your loan payments do not count as 401(k) contributions, and your employer may or may not allow you to keep contributing to your 401(k) while your loan is outstanding.
  • Because the loan is not reported to credit agencies, a 401(k) loan is not a way to build your credit history or increase your credit score.
  • You typically cannot take a loan from a 401(k) you still have with an old employer.

Is a 401(k) Loan a Good Idea?

Those are the nuts and bolts of 401(k) loans, so is taking out a 401(k) loan a good idea? The answer is a definite maybe. There are times where it can be the best option, times where it’s a bad idea, and times where it can actually increase your overall investment return. Regardless, you should be sure to do a deep analysis and determine if you will definitely be able to pay the loan back in a timely manner before utilizing the 401(k) loan.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Matt Becker
Matt Becker |

Matt Becker is a writer at MagnifyMoney. You can email Matt here

TAGS: ,

Advertiser Disclosure

College Students and Recent Grads, Pay Down My Debt

How To Know If Your Student Loans Are Private or Federal

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

How To Tell If Your Student Loans Are Private or Federal

When you borrowed money to pay for college, you may not have paid much attention to the difference between federal and private student loans. You might not know who your student loan servicer is, or if you do, you may wonder for example whether that loan listed under Nelnet is federal or private.

In fact, it’s completely reasonable to ask why the difference between private and federal student loans matters in the first place.

There are a few ways to see if your student loans are private or federal — here’s how, along with what makes each different, and why knowing which type of loan you have is important.

What makes federal and private student loans different?

Federal student loans are offered through the Department of Education. Typically, these loans are easy to qualify for. For many federal student loans, your credit isn’t even checked.

There are four different federal student loan programs currently available:

  • Direct subsidized loans: These loans are awarded based on your financial need. When you apply for federal financial aid, your eligibility for subsidized loans is also considered. “Subsidized” here means that interest isn’t charged until after you graduate or drop below half time.
  • Directed unsubsidized loans: Anyone can receive an unsubsidized loan — they aren’t based on need. However, unsubsidized loans will put you on the hook for interest charges that accrue while you’re in school.
  • Direct PLUS loans: These loans are specifically for graduate students or for parents of undergraduate students taking out loans on behalf of their child. These loans aren’t based on financial need, and a credit check is required.
  • Direct consolidation loans: This type of loan allows you to combine all your federal student loans into one, giving you one manageable payment each month rather than many. Your new interest rate is the weighted average of all your loans, rounded up to the nearest one-eighth of a percent.

Private student loans, on the other hand, are offered by private lenders and have different repayment requirements compared with federal student loans. For example, private student loans can offer fixed or variable interest rates, while federal student loans only offer fixed rates.

Because the features of private loans vary from lender to lender, eligibility will depend on the bank, credit union or online financial institution that you borrow from.

Most borrowers usually favor federal student loans, given the flexible repayment options and debt-forgiveness programs they come with. But since federal loans also have borrowing limits, students may need to turn to private loans to help fund any remaining costs, and in a few cases, a private loan might have a better interest rate than their federal equivalent.

How to determine if your loans are federal

The first thing you should do to see if you have federal loans is log on to the National Student Loan Data System. The only loans listed here are federal.

If you’ve never used the NSLDS before, you’ll want to click the “Financial Aid Review” button on the homepage, hit “Accept,” and then enter your credentials.

If you have a Federal Student Aid (FSA) ID, you can enter it here. If not, there’s an option to create one. In May 2015, the government redesigned its student loan system, and you can now use your FSA ID to log on to multiple government sites. But if you haven’t visited in a while, you might need to create one.

In the event you forgot your credentials, you can click the “Forgot my username/password” button and have the information emailed to you or answer a challenge question. You’ll just be required to enter your Social Security number, last name and date of birth.

Once you log on, you’ll see a list of all the student loans that were disbursed to you. This page will also show you what your original loan amount was, and how much you currently owe.

Click on the numbered box to the left of your loan to determine your loan servicer. This will display all the information about that particular loan. Your loan servicer will be listed under the “Servicer/Lender/Guaranty Agency/ED Servicer Information” section. The name, address, phone number and website should all be displayed.

Additionally, this page will also inform you of your loan terms. Along with your original loan balance and current outstanding balance, it will tell you what the interest rate is and the current status of the loan.

How to determine if your student loan is private

As discussed, private student loans are loans not made by the government — banking institutions, such as Sallie Mae, Wells Fargo, Citizens Bank and others offer them. As a result, there are more lenders to look out for when it comes to private loans.

Unfortunately, there’s no central reporting system for private loans like there is for federal loans, which makes them slightly more tricky to track down.

Your first stop should still be the NSLDS to at least see if you have any federal loans. In 2015, just 5% of undergraduate borrowers had private student loans, so your student loans are more likely to be federal than private.

But in order to make sure you have no outstanding private student debt, you’ll want to take a look at your credit report. You can view your reports from the three main credit bureaus for free by visiting AnnualCreditReport.com.

Some lenders may not look familiar to you. Searching the lender’s name online may help you find out who the parent company is. Don’t hesitate to call the numbers available on your credit report if you’re still unsure.

If you graduated a while ago, some older loans may look unfamiliar. You might see “federal direct loan,” “federal Perkins,” or “Stafford” on your report — these are federal loans, so ensure they match up with what’s in your NSLDS file.

You might also be able to call your school’s financial aid office to see if they have records of your loans.

What should you do once you find out?

Knowing whether your student loans are private or federal can be important as you repay you college debt.

For example, knowing the difference is crucial if you ever decide to refinance or consolidate your student loans. You can only combine your debt under a direct consolidation loan if you have federal loans. Likewise, refinancing through a private lender will cause you to lose access to federal repayment and forgiveness programs, while private loans would be unaffected.

So, by knowing which type of student loans you have, you’ll get a better idea of what options you have to knock them off.

Customize Student Loan Offers with Magnifymoney tools

Dori Zinn contributed to this report.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Erin Millard
Erin Millard |

Erin Millard is a writer at MagnifyMoney. You can email Erin at [email protected]

TAGS: , ,

Advertiser Disclosure

College Students and Recent Grads

5 Reasons You Might Be Denied for a Private Student Loan

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

college-grad

When you’re applying for money to pay for college, experts agree that federal loans are usually the best way to go. They’re less expensive (especially for undergraduates) and more flexible than private student loans.

But if you need more money than you’re being offered in federal aid, a private student loan from a bank or other lender may be your best option to fill the gap. In the most recent numbers on private student loan borrowers, 43% turned to private lenders because they could not borrow any more in federal Stafford loans, according to the Institute for College Access & Success (TICAS).

But if you’re thinking of applying for a private loan, you should know that getting approved isn’t a slam-dunk.

“Lenders are focusing their money on the borrower who is least likely to default and most likely to be profitable,” said Mark Kantrowitz, financial aid expert and publisher of Savingforcollege.com. As a result, applicants who seem even a little risky might find themselves rejected for a private student loan.

Here are five reasons you might be denied for a private student loan:

1. Your credit isn’t good enough

Many undergraduate students — and some graduate students — don’t have a robust enough credit history to qualify for a private student loan. Or, if they do, their score might be too low.

Can you get a private student loan with bad credit? Possibly, but you might need a cosigner on a private loan application to get it approved. “About 90% of our private education loans are co-signed,” said Rick Castellano, a spokesperson for Sallie Mae.

Note, however, that using a cosigner can also cause problems of its own.

2. You’ve borrowed a lot recently

The Department of Education, guaranty agencies and other federal student lenders report your loans to the credit bureaus, as do most private lenders. As a result, future lenders are able to easily see how much money you’re borrowing and what your total debt load looks like.

Your debt-to-income ratio ideally needs to be 40% or less, though standards range from lender to lender. If you have a lot of debt and not much income, you’re a riskier bet, leading private lenders to reject your loan request.

3. You’re going into the ‘wrong’ field

“If you’re applying for private aid for a degree in a field that pays well, like a medical degree or in the sciences, and you’ve got a reasonably good credit background, you’re getting approved,” Kantrowitz said. On the other hand, if you’re pursuing a degree in a field that traditionally pays poorly — thus making it harder for you to repay a loan later — it’s a tougher call.

Keep in mind that your future earnings will also play into your likelihood of getting approved for student loan refinancing after you graduate. We definitely aren’t telling you to avoid pursuing your dreams, just to be careful about your debt burden if you’re entering a historically low-paying field.

4. You’re asking for too much

It could be that the private lender thinks your loan request is too high. “To ensure applicants borrow only what they need to cover their school’s cost of attendance, we actively engage with schools and require school certification before we disburse a private education loan,” Castellano said.

In this case, you might not get rejected, but the school might certify a lesser amount.

Also be aware that you can sometimes get approved for more than you actually need. If that’s the case, you probably shouldn’t use those extra student loan funds to cover the cost of decorating your dorm, grabbing coffee after class or bar hopping. The cost of using student loans to cover living expenses can take a heavy toll down the road.

5. You’re a freshman

If you’re only a year or two away from graduating, you’re more likely to get approved than if you still have four years of undergraduate schooling ahead of you. This is because, as Kantrowitz explained, “there’s less risk of you dropping out.”

Graduate students may also have an easier time getting a private student loan because they’re more of a known quantity — they even started to pay down debt and established themselves as less of a risk.

Why you might be denied for a private student loan (and what to do instead)

In all circumstances, experts feel you should weigh the costs and benefits of private loans carefully — and whether you need them at all. For one thing, 45% of private loan borrowers borrowed less than they could have in federal loans, according to TICAS. So make sure you’ve exhausted your federal loan opportunities before heading this way.

Private student loans can be harder to get than federal ones because they’re credit-dependent. Everything from existing debt and credit scores to how far you are into your education will play a role in whether or not your application is accepted.

But getting denied for a private student loan doesn’t mean that you’re out of luck when it comes to funding college. There are many other options, from racking up scholarships to finding a tuition-free school. You could even start with a low-cost or no-cost community college and then try to build your credit to qualify for a private student loan later on when you transfer to a four-year university.

Devon Delfino contributed to this report.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kate Ashford
Kate Ashford |

Kate Ashford is a writer at MagnifyMoney. You can email Kate at [email protected]

TAGS: , ,