Can I get a hardship loan for money troubles?

If you need financial help to get by, you may look for a hardship loan.

But while financial products marketed as “hardship loans” may solve a short-term emergency, they can be extremely costly — making it even harder to improve your overall financial situation.

So before you borrow, you’ll want to explore other options, such as loan modification, forbearance, payment plans or financial assistance. And if you do decide to apply for a loan, shop around and make sure to calculate the costs — to your budget and your longer-term financial health.

Let’s review what you should know about hardship loans and other options you may have.

• What is a hardship loan?
• Tapping into your 401(k): Hardship withdrawals and 401(k) loans
• Personal loans
• Home equity loans
• Loan or mortgage modifications
• Peer-to-peer lending
• Borrowing from friends or family members
• Riskier options
• Loan relief options during COVID-19

What is a hardship loan?

Although there’s no official definition for a hardship loan, you’ll probably see a couple of options if you search for one — including 401(k) loans or withdrawals and personal loans packaged as “hardship loans.”

Some lenders have responded to the financial downturn caused by COVID-19 by offering “hardship loans” for relatively small loan amounts. In some cases, your first payment might not be due until a couple of months after the loan is issued.

But while some small-dollar lenders offer loans for emergencies, these loans may also come with very high interest rates that can make them tough to repay.

Tapping into your 401(k): Hardship withdrawals and 401(k) loans

Hardship withdrawals from a 401(k) may be the closest option to an actual hardship loan. But you’ll need to have a 401(k) and meet strict criteria to make a hardship withdrawal.

Hardship withdrawals

Hardship withdrawals may be available depending on your 401(k) plan. The law doesn’t require 401(k) plans to provide hardship withdrawals. But if they do, the reasons for the withdrawals must meet IRS criteria for a hardship.

Here are some emergency expenses that may qualify for a hardship withdrawal.

• Out-of-pocket medical expenses
• Down payment or repairs on your primary residence
• College education expenses
• Threat of foreclosure or eviction from your home
• Burial and funeral expenses for an account holder, their spouse, children, dependents or beneficiaries

There are limitations though. IRS rules state that you can withdraw only the amount necessary to cover your emergency expense, and that you can only take the withdrawal after you’ve exhausted other available distributions. Plus, you won’t be able to defer money from your paycheck into your 401(k) for at least six months after taking the distribution.

You’ll also have to pay income tax on the withdrawal and possibly a 10% penalty if you’re younger than 59½. And you can’t avoid the tax consequences by repaying the money you took out or by rolling the money into another plan or IRA.

401(k) loans

Provided your 401(k) plan allows loans, borrowing from your 401(k) can be a low-cost alternative to a hardship withdrawal. Employers may offer 401(k) loans for any reason — meaning you don’t have to be in a difficult financial situation to take one.

Keep in mind that 401(k) loans aren’t “free money.” You’ll need to repay the full amount plus interest. And if you’re unable to repay your loan or you lose your job, you could face penalties and tax consequences. On top of all that, until you repay the loan, you’re also missing out on the potential to grow your invested money.

When considering your financial-hardship loan options, talk to your 401(k) administrator to find out loan criteria and withdrawal qualifications.

Personal loans

Personal loans allow you to borrow a fixed amount of money and pay it back with interest in monthly payments over the life of your loan. Typical personal loan terms range from 12 months to 84 months. And loan amounts typically range from $1,500 to $100,000. Interest rates, which can range from 5% to 36%, vary from lender to lender.

If you have good credit, you may qualify for an unsecured loan with competitive interest rates and favorable repayment terms. If you can secure a personal loan with collateral — like a savings account or CD — you may qualify for a secured loan. Be cautious though — if you can’t repay your secured personal loan, the lender can claim your collateral as repayment.

Take note that applying for an unsecured personal loan with bad credit may have less-favorable rates and terms. Keep a look out for origination fees and prepayment penalties that some lenders tack on to loans.

Home equity loans

A home equity loan lets homeowners borrow money against the equity they’ve built up in their home. Typically, the loans have fixed interest rates, terms and monthly payment amounts.

But be careful about solving a short-term money challenge with your home equity. As with a mortgage, your home is your collateral for a home equity loan. So if you fail to repay the loan, the lender could foreclose on your home.

Loan or mortgage modifications

If your financial hardship is affecting your ability to pay your mortgage, a mortgage modification may be an option. A modification can lower your monthly payments, trim interest rates or reduce your principal balance. Be sure to understand how the changes to your loan terms affect the longevity of your loan and the total amount you owe.

Peer-to-peer lending

When you need a small amount of money, peer-to-peer lending may be a better alternative than using a credit card or taking out a payday loan. Instead of borrowing from a bank or loan company, peer-to-peer lending connects borrowers directly with individual lenders who fund loans in small increments.

Taking out the go-between can allow for a faster lending process and reasonable interest rates for borrowers with good credit. But if you have low credit scores, you may face higher interest rates — sometimes even higher than the average credit card APR.

Borrowing from friends or family members

When money’s tight, lending between friends or family members can be mutually beneficial. Even if you have a poor credit history, a loved one may be willing to give you a no- or low-interest loan. But remember, a loan between family members is still a loan. You should have a contract (even if it’s informal), agree on how you’ll repay the loan (and follow through on repayment), and be aware that the lender may have to pay income tax on any interest you pay.

Before asking for a family loan, it’s a good idea to consider any potential relationship risks, along with how taxes might come into play.

Riskier options

Other lending options include payday loans or credit card cash advances. These options should be a last resort to cover a sudden expense. Here’s why.

• Generally higher interest rates — Depending on state laws, payday lenders can charge about $15 per $100. That roughly equates to a 400% APR for a two-week loan. Credit card cash advances often have a fee for distributing funds (ranging between 3% and 5% or $5 to $10) along with an APR that can be higher than the rate for regular purchases.
• Repayment terms — A payday loan is typically due within two to four weeks. And while you can take your time repaying a cash advance from a credit card, interest generally starts accruing as soon as you take the advance.
• Fees — If you can’t repay a payday loan on time, the lender may tack on late fees, rollover fees and other types of fees. And taking a cash advance could mean you must pay a processing fee.
• Impact on credit — Payday lenders typically don’t report your payment history to credit bureaus, which won’t help you build credit. But with a cash advance, if you pay late, that negative information can show up on your credit reports.
• Your financial situation could get worse — If you can’t repay your loan or advance because of high interest rates or short repayment terms, you could be making your financial situation worse.

Next steps

It would be great if lenders made no- or low-interest loans to anyone suffering a financial hardship, but that’s generally not how the finance industry works. Be cautious of products marketed as “hardship loans,” since they often come with high costs.

If you qualify for one, a 401(k) hardship withdrawal or 401(k) loan could be a lower-cost solution for a significant emergency expense, but both have financial consequences you should consider. Before committing to any kind of credit, be sure you understand the actual cost of the money you’re borrowing and have a plan for how you’ll repay the debt.

If you’re committed to moving forward with one of these options, here’s what to do next.

1. Check your credit scores. This can help give you an idea of whether you’ll get approved and what kind of interest rates to expect.

2. Ask yourself some questions to help narrow down what type of loan might work for you.  

• Are you eligible for the option?
• How much will this cost? Will there be interest payments or taxes?
• How long do you have to repay the money?
• How much can you borrow?

3. Shop and compare. Once you’ve decided on the type of loan that makes the most sense for you, look at a number of lenders. For example, if you decide to get a home equity loan, you’ll want to check several loan issuers to find the one with the best terms for your situation.

4. Apply. Once you’ve picked your target, it’s time to submit an application! It might be good to have a couple of backup options in mind in case you aren’t approved. And take note that applying for financial products could result in hard credit inquiries, which could affect your credit scores a bit temporarily.

It’s important to take some time to research all of your options. When you’re facing a financial hardship, the last thing you want to do is make your situation worse by paying more than you need to for a loan.