2) Should I default on the loan, take the 28% plus 10% penalty if the 401K managers do not allow me to continue payments?

I don't believe I'm typing this, but I think your best bet might well be to borrow that $5000 on your credit card or other unsecured loan if you can get one.

NO! WAIT! Please! Hear me out! Don't take away my Motley Fool Decoder Ring!

From what I read from your message, you have a $5K 401k loan which was due to be paid off in 2 years. I also come up with a monthly payment of about $225, assuming an 8% rate.

If you take the 10% penalty, that's $500 off the top. Plus, you can't put the funds back into the 401k and thus you lose a tax deferral.

On the other hand, if you borrow it from a credit card company at 15% and put that $225 towards your paying it off, you'll pay it off in 26 months, costing $889 in interest ($34 per month), versus $500 in penalty. That seems to me to be a small price to pay to keep that money in the tax-deferred account.

It gets better if you have access to lower-cost credit than 15%.

Good Luck,
JDOyster