401(k) Loan vs. A Traditional Bank Loan for Your Business
Applying for a loan is one of the most common ways budding entrepreneurs secure startup cash. Popular options include securing personal loans from a bank or traditional lender or borrowing against your 401(k) retirement account. Weigh the benefits and drawbacks of 401(k) loans and traditional bank loans for your business to make an informed decision.
Traditional Loans: Pros and Cons
Thinking about applying for a traditional loan at your bank? It’s a popular option for many reasons. Let’s look at the advantages and disadvantages of this funding solution.
Pros
Banks often lend higher amounts of money than typically available in a 401(k) account. If you need a hefty chunk of cash quickly, a bank loan may be right for you. Plus, you’re leaving your retirement savings alone, minimizing your risk to personal assets. Should your business fail to turn a profit, you won’t lose your retirement account as collateral damage.
Cons
When applying for a traditional bank loan, the lender will run a credit check on you. You will likely need good to excellent credit in order to qualify for a traditional loan; a checkered history may lead to a denial.
If you do secure a bank loan, you’ll probably wind up paying higher interest rates than you would on a 401(k) loan. The interest payback process increases the overall cost of the loan.
401(k) Loans: Pros and Cons
Borrowing against your 401(k) allows you to skip some of the steps involved in traditional loans, but this type of lending also has potential disadvantages.
Pros
When you take out a loan against your 401(k), you can access your funds more quickly than with a bank loan. After all, it is your money!
The interest rates you pay on a 401(k) loan are generally much lower than those on traditional loans. In addition, the money you pay in interest goes right back into your 401(k); you’re essentially paying yourself.
Cons
When investing your own money in your business via a 401(k) loan, you risk losing it all if your business fails to turn a profit or goes under completely. Think carefully about that risk before dipping into your savings! Additioannly, there’s a limit to how much you can take out of your 401(k) with a loan. You can borrow either 50 percent of your vested balance or $50,000—whichever amount is less.
The Bottom Line
Choosing between traditional and 401(k) loans is one of the most important decisions you’ll make as a new business owner. Think about the risks you’re willing to take and how confident you are that your business will succeed.
If you want to utilize your 401(k) funds without going through the loan process, consider trying 401(k) business financing instead. The rollover process allows you to move those funds into a new business account without incurring withdrawal penalties. Plus, rollover financing is not a loan, so you don’t have to worry about repayments!
Weigh the benefits and drawbacks of traditional bank loans and 401(k) loans as you search for funding options for your business. Interested in learning more about financing options that can boost your business? Head over to Pango Financial’s funding solutions tool for more in-depth information.