Many 401(k) plans permit participant loans in the hopes of increasing participation by allowing access to funds. While loan procedures and terms will vary by plan, general federal regulations regarding 401(k) loans include:

• A loan from your 401(k) plan is not considered a distribution from the plan. Thus, you do not have to pay income taxes or the 10 percent federal penalty.
  
   
• 401(k) plans are not required to offer loans to participants. While most plans that allow loans permit them for any purpose, some plans designate the purposes for which loans can be taken.
  
   
• The amount of the loan cannot exceed 50 percent of your vested interest in the plan or $50,000, whichever is less. If you have another loan outstanding, that amount is subtracted from the maximum amount that can be borrowed. Although there is no federally mandated minimum loan balance, individual plans often impose a limit to reduce administrative costs.
  
   
• The loan usually must be repaid in five years, unless the proceeds are used to purchase a primary residence. Longer repayment periods can be made available for those loans. Principal and interest payments must be made on at least a quarterly basis.
  
   
• The loan's interest rate must equal the prevailing rate charged for similar loans. Typically, that rate equals one or two percentage points over the prime rate.
  
   
• If you terminate employment before the loan is repaid in full, the entire outstanding balance must be paid immediately. Otherwise, the unpaid principal will be considered a 401(k) distribution, subject to income taxes and the 10 percent federal penalty if you are under age 59 1/2.

Borrowing from your 401(k) plan is a convenient way to obtain money. There are no credit checks or lengthy applications to fill out. Typically, you receive the loan proceeds in a couple of weeks. Before borrowing from your 401(k) plan, however, consider a couple of important factors.

Although the interest rates charged on 401(k) loans are typically attractive, remember that you are foregoing investment growth on the outstanding principal. Since some of your investments were sold to provide you with the loan proceeds, your account earns the stated loan interest rate on the outstanding principal. The attractive interest rate on your loan may seem very expensive if you miss a major rally in your investments.

Review the repayment terms to make sure you can easily repay the loan. You don't want to reduce or eliminate new 401(k) contributions because you are struggling to repay your loan balance.

Consider other loan options. If you have equity in your home, consider a home-equity loan instead of a 401(k) loan. Interest rates on home-equity loans tend to be comparable to rates on 401(k) loans. In addition, the interest paid on the home-equity loan is typically tax deductible if the loan balance is less than $100,000. Since interest paid on a 401(k) loan is not tax deductible, a home-equity loan may actually have a lower after-tax cost.