401K Mortgage Loan Rules

A 401k plan loan can assist you with your mortgage down payment.house image by hans slegers from Fotolia.com

The Internal Revenue Service permits 401k plans to offer loans to account holders. These loans can be used for any purpose, do not require a credit check and, as long as you repay the loan as agreed, have no tax implications. If you take a loan for a mortgage down payment, the repayment period is extended. However, not all plans elect to offer loans so you need to check with your 401k plan administrator to determine if you can take a loan from your 401k plan.

Maximum Loan Amount

401k plan loans are limited to 50 percent of your vested account balance or $50,000, whichever is smaller. Your vested account balance includes all of the contributions you have made, the earnings on those contributions, and the contributions and earnings of employer contributions that you are entitled to keep if you left the company. For example, if your 401k plan is fully vested and is worth $200,000, the most you could borrow would by $50,000. However if your plan was worth only $30,000, your maximum loan would only be $15,000.

You can take up to ten years to repay a 401k plan loan that you use for a down payment on your home. Other 401k plan loans are limited to only a five year repayment period.

The IRS requires that payments on the 401k plan loan be made at least quarterly on the loan. In addition, the loan must charge interest at a rate specified by the rules for the plan. The interest rates for 401k plan loans are usually competitive, according to Smart Money. The interest that you paid goes back into your 401k plan. However, if you leave your job, even if it is because you got fired or laid off, you must pay back the loan in full at that time.

If you fail to repay the loan, the IRS will consider the amount of the loan that has not been repaid to be distributed from the account. This amount will always be taxable and, if you are under age 59 1/2, you will have to pay a 10 percent penalty. For example, if you fail to repay $15,000, you will have to report an additional $15,000 in taxable income and pay $1,500 in tax penalties.