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nothing in the OP suggested they were going to deplete their 401k account, just that they were using some of it for a hardship. I did this year's ago (first house..now on 4th LOL) to get part of a down payment. In the end, I agree that it's not always the best idea to pull retirement funds but some can depend on age, financial situation, etc. That 10% penalty did stink though (but we were in a much lower tax bracket back then...if I pulled out money now, even without the 10% penalty, my taxes would be at least 10% more than they were then)!

I agree with C. B. Zeller those articles are written for the average person and they use language that makes sense to them. In many ways it looks like you are paying interest to yourself but legally speaking it is paid to the plan and allocated to your account. In my world the common way of explaining an ESOP is legally incorrect. It is often times said you own stock in the company in your account. For most purposes that is a good description but legally speaking all the stock in an ESOP is owned by the trust and the participants are a beneficiary of the trust. There just isn't much practical value in all the extra verbiage when doing an enrollment meeting so it is skipped and we talk about how the participants own the stock of the company. Even in a 401(k) plan we talk about how you are invested in this or that mutual fund like you own the mutual fund. Legally speaking the trust owns all the assets and the participant is the beneficiary of the trust. The poor person who asked the original question getting hit with these technical side conversation! To that person I agree with the other people go talk to HR and see if there is some kind of misunderstanding as I have never in my decades seen a rule like you describing.

Does the plan get the interest on the loan? YES IT DOES. That's the law. Now, how that return on investment gets allocated is another issue, and in many plans it is allocated back to the participant who borrowed the money. In many of my plans (with no participant direction) it is not. It is simply another investment of the plan (it's a lot like a bond). Our QP world is full of technical issues that are confusing to the lay individual (and rightfully so). That's a good thing because that's why employers need people like us! (that's sarcasm). Did you know that employee 401(k) deferrals are also NOT employee contributions? Legally, they are EMPLOYER contributions. And while that makes no sense at all to the lay person, it actually makes perfect sense when you understand our convoluted tax laws.

It is also possible that his company has outsourced the administrative services to Vanguard. If so, only Vanguard can help (or not).