How Do 401(k) Loans Work: Limits, Repayment, and Default

A 401(k) loan lets you borrow from your own retirement account and pay yourself back with interest, without owing income taxes, as long as you follow the IRS rules. Federal law caps the loan at the lesser of $50,000 or 50% of your vested balance, sets a repayment period of five years for most purposes, and requires substantially level payments at least quarterly. Break those rules and the outstanding balance turns into a taxable distribution, often with a 10% penalty on top. Here is how the process works from application through repayment, and where the real costs sit.

How Much You Can Borrow

The ceiling is the lesser of two figures: $50,000, or 50% of your vested account balance. If your vested balance is $80,000, your maximum is $40,000. If it’s $120,000, the 50% figure would be $60,000, but the $50,000 hard cap takes over.¹

There’s a floor most people miss. If half your vested balance is under $10,000, the law lets you borrow up to $10,000 anyway. A $15,000 vested balance would give you a 50% figure of $7,500, but you could still borrow $10,000. Your plan isn’t required to offer this higher minimum, only permitted to.¹

A recent loan shrinks the $50,000 cap. The limit is reduced by your highest outstanding loan balance during the 12 months ending the day before the new loan. Borrowed $30,000 last year and paid it down to $10,000? Your new maximum is $20,000, not $40,000: the $50,000 cap minus the $30,000 high-water mark.¹

Federal law doesn’t limit you to one loan at a time; the combined balances just have to stay under the borrowing cap, and each loan has to meet the repayment rules on its own. Your plan can be stricter. Many cap participants at one or two active loans, set a minimum loan amount (often $1,000), or restrict which accounts you can borrow from.² Some plans don’t offer loans at all. Only your vested balance counts; unvested employer matching contributions can’t be used as collateral. Check your plan’s summary plan description before you count on anything.

Applying and Getting the Money

You apply through your employer’s benefits portal or directly with the plan’s third-party administrator, such as Fidelity, Vanguard, or Empower. The application asks for a dollar amount and a repayment term. The administrator confirms your vested balance, checks the request against the borrowing limits, and applies any plan-specific rules.³

The IRS requires the loan to be documented as a legally enforceable agreement, on paper or electronically, showing the date, amount, interest rate, and a binding repayment schedule. Without that documentation, the IRS can treat the whole amount as a taxable distribution rather than a loan.³

Most administrators charge a one-time origination fee, commonly in the $50 to $125 range, and some also charge a small annual maintenance fee while the loan is outstanding. These come out of your account balance.

Once approved, the administrator sells investments in your account to raise the cash, which usually takes two to three business days. You then receive the funds by direct deposit or check, generally within five to seven business days of final approval.

Repayment and Interest

You repay through substantially level payments, meaning a fixed amount covering principal and interest, made at least quarterly. In practice, most plans deduct payments automatically from each paycheck, on an after-tax basis rather than pre-tax.⁴

For general-purpose loans the maximum repayment period is five years. Miss that deadline, or fall out of the level-payment schedule, and the outstanding balance can be converted into a taxable distribution.⁴

The interest rate is typically prime plus 1%. As of early 2026, prime is 6.75%, putting a typical 401(k) loan rate near 7.75%. Your credit score doesn’t factor in; every borrower in the same plan pays the same rate. The interest goes back into your own account, so it isn’t a cost in the usual sense — it partially replaces the investment growth the borrowed money is missing.

Home Purchases

If the loan is used to buy your primary residence, the five-year rule doesn’t apply. The statute doesn’t set a specific maximum for these loans; plans that offer the option commonly allow 10 to 15 years. Your administrator may require documentation of the purchase, such as a signed contract or closing disclosure, before approving the longer term.⁵

Unpaid Leave

Your plan can suspend payments for up to one year during an unpaid leave of absence. The five-year deadline doesn’t move, though. When you return, you’ll need to either increase your payments or make a lump-sum catch-up to finish on time.³

Active-Duty Military

If you’re on active duty, your plan can suspend loan payments for longer than one year, and your five-year repayment deadline is extended by the length of your military service.³

If You Leave Your Job

Leaving your employer — whether you quit, are laid off, or are fired — changes the loan right away. Most plans accelerate the balance, so the entire remaining amount becomes due. You typically have a limited window, often 60 to 90 days depending on plan terms, to pay it off. Otherwise, the unpaid balance is treated as a distribution.

The Tax Cuts and Jobs Act (Section 13613) gave borrowers more room to fix this. If the loan balance is offset because you left your job or the plan was terminated, you can roll the unpaid amount into an IRA or another eligible retirement plan by your tax filing deadline for that year, extensions included. If you left in 2026, that generally means until October 15, 2027 with an extension.⁶

Partial rollovers work too. You can roll over whatever portion you can afford, and only the remaining amount is taxed as income.⁵

Missed Payments and Default

Miss a required payment and your plan may give you a cure period. IRS regulations allow the cure period to run through the last day of the calendar quarter following the quarter in which the payment was missed. A payment due in May (second quarter) can be cured by September 30 (end of the third quarter).⁷

If you don’t catch up by the end of the cure period, the entire outstanding balance, principal plus accrued interest, becomes a “deemed distribution.” No cash actually leaves the plan, but the IRS treats it as if it did. The administrator reports it on Form 1099-R with distribution Code L.⁴

Two tax hits follow:

The full deemed distribution is added to your taxable income for the year at your ordinary federal rate. State income tax may apply as well.
If you’re under age 59½, an additional 10% early withdrawal penalty applies.⁸

On a $30,000 defaulted balance, a borrower in the 22% federal bracket who is under 59½ could owe roughly $9,600 in combined federal tax and penalty, before any state tax. That’s why using the cure period or a plan loan offset rollover matters so much when things go sideways.

The Costs You Pay Even When You Repay on Time

Two costs survive even a perfectly repaid loan.

The first is on the interest. Your original contributions were pre-tax, but you repay the loan, interest included, with after-tax dollars from your paycheck. When you eventually withdraw the money in retirement, the whole balance is taxed again as ordinary income. The principal isn’t truly taxed twice because it replaces pre-tax money already in the account, but the interest is: once when you earn the wages to repay it, and again on withdrawal.

The second is lost investment returns. While the money is out of the account, it isn’t invested. The interest you pay yourself (around 7–8% at current rates) may not match what your investments would have earned. In a strong market, the gap can be significant; in a flat or falling market, the loan might work in your favor. Either way, you’re taking a position against your own portfolio.

What About Your Credit Score

A 401(k) loan doesn’t show up on your credit report, doesn’t require a credit check, and doesn’t affect your score, even if you default. The loan is between you and your plan, not a third-party lender, so nothing gets reported to the credit bureaus. That can make borrowing attractive if your credit is weak, but the tax bill on a defaulted loan can be just as painful as a credit hit.

1
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
2
Internal Revenue Service. Issue Snapshot – Borrowing Limits for Participants With Multiple Plan Loans
3
Internal Revenue Service. 401(k) Plan Fix-It Guide – Participant Loans Don’t Conform to the Requirements of the Plan Document and IRC Section 72(p)
4
Internal Revenue Service. Retirement Plans FAQs Regarding Loans
5
Internal Revenue Service. Retirement Topics – Plan Loans
6
Internal Revenue Service. Plan Loan Offsets
7
Internal Revenue Service. Issue Snapshot – Plan Loan Cure Period
8
Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules