When you want to borrow from your 401(k) to settle an emergency, hesitation might creep in when you consider the effect of such a loan on your credit history. Since conventional loans typically show up on credit reports, you might be concerned that borrowing from your 401(k) nest egg will also be captured in your credit report and potentially affect your credit score.
401(k) loans don’t show up on credit reports even when defaulted because they’re not reported to or tracked by credit bureaus, and they don’t trigger an inquiry. Moreover, such loans involve borrowing against one’s own assets, which doesn’t increase debt.
Read on to learn more about 401(k) loans, why they don’t appear on your credit report, and their financial implications.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
A Quick Overview of 401(K) Loans
Technically, a 401(k) loan isn’t a loan per se. When you take out one of these, you borrow from your own assets in that your employer lends you money from your 401(k) savings. Some employers don’t allow it altogether, while others put restrictions on the amount you can borrow and the purposes for which you may seek a loan.
A major advantage of taking a 401(k) instead of a conventional bank loan is that it’s more readily available. It also comes at a lower interest rate.
But do the benefits of a 401(k) loan extend to your credit score (i.e., not affecting it negatively like a traditional loan would)?
Let’s find out in the next section.
Will a 401(K) Loan Appear on Your Credit Report?
A 401(k) loan won’t show up on your credit report because they’re not reported to or tracked by credit bureaus, and they don’t trigger an inquiry. Because 401(k) loans let you borrow against your assets, it doesn’t increase your debt or get you in trouble when you defaulted on your loan.
The first part of the explanation is that you’re borrowing money that you already own, which technically makes you your own lender. As such, your loan doesn’t increase your debt. If it did, this would increase the amount you oweーone of the five primary determinants of your credit scoreーand thus appear on your credit report.
Secondly, obtaining a 401(k) loan doesn’t trigger an inquiry.
As an FYI, inquiries occur when a legally authorized individual (including you) or organization accesses your credit information. They’re most commonly triggered by a new application for credit but may also arise from:
- An account review by a business entity you transact with
- Receipt of a preapproved credit offer
There are two inquiry types: a hard inquiry and a soft inquiry.
Generally, loans trigger a hard inquiry, while account reviews and preapproved credit trigger a soft inquiry. A hard inquiry can temporarily affect your credit score (albeit to a small extent), while soft inquiries generally don’t.
Typically, any financial activity from your end resulting in either type of inquiry appears on your credit report. So if a 401(k) loan triggered a hard inquiry like other loans, it would certainly appear on your report and a hard inquiry. But it doesn’t, which is one reason it won’t show up on your credit report.
The third explanation for why 401(k) loans don’t show up on credit reports is that plan administrators don’t report them to credit bureaus.
When you apply for such a loan, your plan administrator (i.e., your employer) can approve or reject your application. In this sense, they act in a lender’s capacity. Since they function as the “lender” (even though it’s still your money), they’d be inclined to report the loan to credit bureaus under normal circumstances (like many other lenders).
However, this isn’t the case because your employer isn’t set up as a lending organization and thus operates under different regulations.
Besides, Experian, TransUnion, and Equifax typically don’t track 401(k) activity. So even if your employer reported a 401(k) loan (hypothetically speaking, because they don’t), it would have no impact on your credit score and thus wouldn’t appear on your report.
Do 401(K) Loan Defaults Go on Credit Reports?
We’ve established that the act of taking out a 401(k) loan won’t be reflected on your credit report. But what if you don’t repay the loan? Will that reflect negatively on your repayment history?
401(k) loan defaults do not show on your credit reports. Whether you repay the loan late or fail to pay altogether won’t be captured in your credit report because credit bureaus don’t track 401(k) loans. Thus, defaulting to such a loan won’t negatively affect your credit history.
However, this comes with two downsides.
Firstly, it means that any timely repayments you make won’t benefit your credit history. That’s unlike a conventional loan, where time repayments not only reduce your debt but also help you build a positive history.
Secondly, plan administrators typically report unpaid 401(k) loans to the IRS as a distribution. When this happens, you owe taxes on the amount you took out because 401(k) plans are usually set up with tax-deferred money. Depending on your age (i.e., whether you’re younger than 59 ½ years), you might also be looking at a 10% tax penalty on top of your usual income tax rate.
How 401(K) Loans Affect Other Loan Applications?
More often than not, people worry about a 401(k) showing up on their credit report because they’re concerned about being denied other loan types. If you’re looking into the subject, chances are you’re concerned about that, too, so we might as well address it.
Even though a 401(k) loan won’t appear on your credit report, it can affect your eligibility for other loans.
Let me explain.
When applying for some loans (especially mortgages), prospective lenders may specifically ask whether you have an outstanding 401(k) loan. Typically, you’ll be required to disclose this information to avoid violating full disclosure agreements.
If you have an outstanding 401(k) loan balance, the lender might count it as a debt and factor it into your debt-to-income ratio (DTI). That can happen even though a 401(k) usually does not affect your DTI.
Lenders usually use it as creditworthiness evaluation criteria alongside credit scores and credit reports. The lower your DTI, the higher your chances of qualifying for a loan一 Experian estimates that most lenders prefer debt-to-income ratios under 36%.
If a lender treats a 401(k) loan as a debt, it’ll increase your DTI. Given that high DTI means you make less than you owe, it might cause a prospective lender to reject your loan application even with an impressive credit report and score.
So while a 401(k) loan doesn’t affect your credit score, it can compromise your ability to secure other loans.
Other Financial Implications of a 401(K) Loan
In addition to affecting your eligibility for other loans, a 401(k) loan comes with other undesirable financial implications that include:
- Opportunity costs: The money you take out of your retirement plan is no longer invested until you repay it. Thus, you stand to miss out on potential gains your nest egg would have realized if you left the money untouched.
- Tying you to your current employer: Leaving your current employer before you’re done repaying the loan comes with tax consequences. If you don’t roll over the outstanding balance into a qualified retirement account, you’ll need to repay it in full before that year’s tax return filing deadline. Otherwise, the outstanding balance will be treated as a distribution and incur a 10% tax penalty.
- Tax implications: Besides the tax levied on the loan and the potential tax penalty, a 401(k) loan also comes with another tax implication that often flies under the radar. To demonstrate that, let’s assume you’ve borrowed $300 and your tax rate is 24%. To repay this amount and still cover taxes, you’d need to make a little more than $394.
On the bright side, a 401(k) loan can help you pay off credit card debt, improve your credit score, and repay yourself at a lower interest rate. It can also come in handy in emergencies.
Author’s Recommendations: Top Trading and Investment Resources To Consider
Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.
- Roadmap to Becoming a Consistently Profitable Trader: I surveyed 5000+ traders (and interviewed 50+ profitable traders) to create the best possible step by step trading guide for you. Read my article: ‘7 Proven Steps To Profitable Trading’ to learn about my findings from surveying 5000+ traders, and to learn how these learnings can be leveraged to your advantage.
- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
- Best Trading Courses You Can Take For Free (or at extremely low cost): I reviewed 30+ trading courses to recommend you the best resource, and found Trading Strategies in Emerging Markets Specialization on Coursera to beat every other course on the market. Plus, if you complete this course within 7 days, it will cost you nothing and will be absolutely free! Click Here To Sign Up Today! (If you don’t find this course valuable, you can cancel anytime within the 7 days trial period and pay nothing.)
- Best Passive Investment Platform For Exponential (Potentially) Returns: By enabling passive investments into a Bitcoin ETF, Acorns gives you the best opportunity to make exponential returns on your passive investments. Plus, Acorns is currently offering a $15 bonus for simply singing up to their platform – so that is one opportunity you don’t want to miss! (assuming you are interested in this platform). Click Here To Get $15 Bonus By Signing Up For Acorns Today! (It will take you less than 5 mins to sign up, and it is totally worth it.)
Conclusion
Although taking out a 401(k) loan won’t affect your credit report, it may affect your eligibility for loans such as mortgages. It can also mean missing out on potential earnings in your nest egg, tie you to your current employer, and bring about tax consequences.
And while defaulting on such a loan won’t affect your credit history, repaying on time won’t benefit it, either. On the other hand, such a loan makes sense when you have high credit card debts and maybe a godsend in an emergency.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
Affiliate Disclosure: We participate in several affiliate programs and may be compensated if you make a purchase using our referral link, at no additional cost to you. You can, however, trust the integrity of our recommendation. Affiliate programs exist even for products that we are not recommending. We only choose to recommend you the products that we actually believe in.
