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I was looking at some information about my 401(k) and noticed that it's possible to take out a loan from your 401(k) - it was something like 6.5% interest, which probably isn't as good as a conventional loan/mortgage...
But if the 6.5% interest is going back into my 401(k), that's vastly better than it going to the bank, right? So who does the interest go to from a loan against a 401(k)? My 401(k)? Or somewhere else?
The "interest" just goes back into your 401(k), but there's also an opportunity cost. You miss out on any gains that the money would have earned if you had not borrowed it, so from a cash flow standpoint the interest is 6.5% - meaning you pay it back as if it were a loan at 6.5% - but from a wealth standpoint the cost could be higher, depending on how long you take the loan out for.
Also, note that if you leave your job (voluntarily or involuntarily), the entire remaining balance will be due immediately, otherwise it will be treated as a distribution and subject to income tax and a 10% penalty. Plus, you might be forced to decline better employment opportunities since you would have to pay the loan back.
Generally 401(k) loans are considered too risky considering the opportunity cost and the possibility of getting hit with a tax bill.
There are some plans with a provision that if a 401(k) loan is outstanding, you cannot make new deposits, only payments to the loan. This would keep you from getting any matched funds, potentially giving an effective rate on the loan into the 100%'s. e.g. you borrow $10K for 5 years. You lose $5K/yr in matching, every year the loan is outstanding.
Aside from the above, ask 2 questions, separately.
If both of the above are "yes", you just need to consider the risk that if you lost you job or even changed jobs, the loan needs to be paid back.
My informed opinion is that one 'fix' that 401(k) accounts need is the ability to maintain a loan post employment. It's awful to consider that one might be offered a better job, higher pay, but realize they are tied to an outstanding loan and would have to jump through hoops to raise funds to pay it back, transfer the 401(k) to new employer, then take out new loan. A transfer of the 401(k) with the loan intact should be an option.
Similarly, if one lost their job, the payback is just an extra burden. The loan should remain, and the administrator assess a small fee for processing it outside the normal payroll deduction. Very small fee.
And, yes, the answer to the question title, is that the interest charged goes back to you.
Yes, it goes back into your 401(k), and you can think of it as the "earnings" from the "investment" of loaning money to you.
Whether that's "better" or "worse" than borrowing the same amount from a bank and then investing your 401(k) money in other ways is a matter of opinion. By loaning that money to yourself, it's not otherwise being invested in some other investment that could be earning a higher rate of return than the 401(k) interest rate; but on the other hand, it's guaranteed to earn that rate of return with no "risk", which you can't say for most investments.
Note that, like all loans, you would have paid tax on the interest more times than you get to keep. Like all loans, you get the money after-tax (you don't need to pay tax on getting the money), and you pay the money back, including the interest, with after-tax money, so you would have paid income tax once on the interest that you don't get to keep. Although in a 401(k) loan the interest is paid into the 401(k), it is treated like any other investment "earnings" in the 401(k) that will need to be taxed when you take it out if it's a Traditional 401(k). (Some people like to say you get taxed "twice" on the money; but it's really just a combination of getting taxed "once" on interest you don't get to keep as a borrower, plus getting taxed "once" on earnings you get to keep once as a lender, so it's no different than any loan you get from a bank, except you're the lender.)
An additional consideration
A major risk is that you leave your job or your employer makes a major change to their plan. I worked at a company where several of my friends had 401k loans and had to pay the full amount back immediately because our company was part of an acquisition and they closed out our old 401k plan.
The interest from a 401k loan goes into your 401k -- you are borrowing the money from yourself: Source
