The real cost of a 401(k) loan
The stated interest rate on a 401(k) loan is usually prime rate plus 1 or 2 percent — currently around 8 to 9%. You pay this interest back to yourself, which sounds free. But the real cost is opportunity cost: money sitting as a loan is not invested and is not compounding. Over 5 years, $20,000 that could have grown at 8% annually would be worth $29,400. As a loan at 9%, you get the $20,000 back plus $4,700 in interest — but you missed $9,400 in market growth.
There is also double taxation risk. The loan repayments come from after-tax dollars — money that has already been taxed. When you withdraw funds in retirement, you pay income tax again on those same dollars. This is unlike traditional 401(k) contributions which are taxed only once at withdrawal.
The job loss risk: pay it back fast
The most serious risk of a 401(k) loan is what happens if you leave your job — voluntarily or not — before the loan is repaid. Most plans require full repayment within 60 to 90 days of separation. If you cannot repay, the outstanding balance is treated as a taxable distribution.
For a $15,000 outstanding balance at the time of job loss, the tax hit could be: $3,750 in federal income tax (25% bracket) plus $1,500 in 10% early withdrawal penalty (if under 59½) = $5,250 in total costs. What started as a loan at a low interest rate becomes a very expensive transaction. The faster you pay it off, the more you eliminate this risk.
If you are even slightly uncertain about your job stability, treat your 401(k) loan as urgent regardless of its rate compared to other debts.
How to pay off your 401(k) loan faster
Make additional lump-sum payments
Many plans allow additional loan payments beyond the required payroll deduction. Contact your plan administrator or check your plan documents to confirm the process. Apply tax refunds, bonuses, or other windfalls directly to the loan balance. Each extra payment shortens the loan term and gets money back into your account where it can compound.
Increase your payroll deduction
Some plans allow you to increase your loan repayment amount through payroll. If yours does, increase the deduction to the maximum comfortable amount. This is the simplest approach since it happens automatically with each paycheck and does not require remembering to make separate payments.
Use a personal loan to pay off the 401(k) loan
If you have strong credit (720+), a personal loan at 8 to 12% APR can make sense to pay off the 401(k) loan — especially if your job security is uncertain. You eliminate the job-loss default risk entirely. The money returns to your 401(k) immediately and resumes compounding, and you repay the personal loan over time without the retirement account at risk.
Should you pause 401(k) contributions to pay off the loan?
This is the most common question. The answer depends on whether your employer offers a match. If your employer matches contributions up to a certain percentage, never stop contributing enough to get the full match — that is a 50 to 100% guaranteed return on your contribution that no loan payoff can beat.
Beyond the match: contributions above the match threshold could be redirected to loan payoff temporarily. If you are contributing 10% and the match is on the first 4%, consider reducing to 4% (keeping the full match) and directing the remaining 6% equivalent to extra loan payments. Restore the full contribution rate once the loan is paid off.
401(k) loan vs. other debts: payoff priority
Purely on rate, a 401(k) loan at 9% is less expensive than credit card debt at 20 to 29%. But the default risk (job loss) and opportunity cost make it more urgent than the rate alone suggests. A practical framework:
Use the debt payoff planner to model your complete debt stack and find the sequence that fits your risk tolerance.
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