Should you use your 401(k) to pay off your mortgage?

When your mortgage balance dips to a point where you can see a clear payoff on the horizon, you may be tempted to pay it off with your retirement funds. Using your 401(k) to pay off your mortgage is a tantalizing possibility because it means no more monthly payments on your home. Learn more about how this works, as well as the pros and cons.

How to use a 401(k) to pay off your mortgage

Here are the steps to take if you decide to pay off your mortgage using 401(k) funds.

First, request a mortgage payoff statement, which will tell you how much you need to pay off your loan completely. Compare the remaining mortgage balance with the amount in your 401(k) to make sure you have enough for the payoff.

Next, figure out how much your tax bill or other penalties will be for an early withdrawal from your 401(k). Determine how much you’ll owe in penalties against the mortgage interest amount you’ll save – you’ll want to make sure it makes sense for your situation and that you’ll save more in interest than you’ll pay in 401(k) penalties.

The last step: Decide between a 401(k) withdrawal or a loan. A withdrawal means you permanently remove the money, while a loan involves repaying the amount, including interest.

A few notes:

• Check to see if your 401(k) plan permits loans. Some do not.
• Loans don’t have the same withdrawal penalties, including income tax or penalty fees, but they do have to be repaid with interest.
• You don’t need a credit check or a minimum credit score to qualify.

You may lose the potential for investment gains on the money you borrowed, and you can also only borrow a certain amount for no more than five years. Your interest payments also aren’t tax-deductible, and you may be charged loan processing and maintenance fees.

Withdrawals and loans need to be done through your 401(k) plan administrator, so check with your company’s human resources office. Your administrator can walk you through the paperwork to get your funds. Once your funds are disbursed, you can reach out to your mortgage lender to make a final payment on the loan.

Pros and cons of using a 401(k) to pay off a mortgage

There are both advantages and disadvantages to using retirement funds to pay off a mortgage. You’ll save on mortgage interest by paying off your mortgage early, but you may get a tax bill for a 401(k) withdrawal.

Pros

First, the benefits of using a 401(k) to pay off your mortgage:

• Eliminate your mortgage payment. Once you pay off your house, you’re done making payments, which means you’ll have one less bill to pay each month. Plus, you’ll increase home equity, which you can tap into later if you need it.
• Save on mortgage interest. If you pay off your mortgage early can save you money on overall interest. This is especially appealing if you have a high mortgage interest rate and can’t find a lower mortgage refinance rate.
• Easier estate planning. Owning a home outright can make it easier to leave it to a family member in your will. It can make estate planning much clearer for your descendants.
• If you use a 401(k) loan to pay off your mortgage, the interest you pay goes back into your retirement account.

Cons

There are also downsides to consider when you use a 401(k) to pay off your mortgage:

• Depleted retirement savings. You’ll reduce your retirement savings, which may affect your timeline for retiring. It’s important to consider your age and your future retirement plans. Consider consulting with a trusted financial advisor before withdrawing money from your retirement account.
• Potential penalties. If you’re under the age of 59½ may have to pay a 10% tax penalty on withdrawals. In addition, if you take out a loan instead of a withdrawal, you may have to pay back the loan very quickly if or when you leave your current employer.
• Loss of mortgage interest deduction. Paying off your home means you’ll no longer be able to take advantage of the home mortgage interest deduction on your taxes, which will increase your tax bill. You must itemize taxes to get the deduction.
• Not tax efficient. If you take a 401(k) loan, you will repay the loan with after-tax dollars. When you eventually withdraw those funds later on in retirement, you will pay taxes on them again, which means being taxed twice on the same money.

Additional considerations when using a 401(k) to pay off a mortgage

What else do you need to know when using a 401(k) to pay off a mortgage? Let’s look at a couple of other factors to consider.

Market conditions

If mortgage rates are low, it could make more sense to refinance than to pay off your loan with retirement funds. If your investments are performing well, you may want to think twice about disrupting your 401(k) portfolio, because you’ll lose out on time and money in the market.

Age

Making withdrawals at a younger age means you’ll pay a tax penalty. Younger workers who borrow against their 401(k) also have more time to build up their retirement funds before they stop working.

Alternatives to using your 401(k) to pay off your mortgage

You can tap into other ways to reduce mortgage payments without paying off the mortgage using retirement funds.

Refinancing

If current mortgage rates are low, refinancing can reduce your mortgage payments. Refinancing means replacing your existing mortgage with a new mortgage.

Downsizing

Selling your current home and downsizing to a less expensive property can reduce or eliminate your mortgage payment. This option is best suited for individuals who have sufficient home equity to purchase a less expensive property.

The bottom line on using your 401(k) to pay off your mortgage

Using your 401(k) to pay off your mortgage is a big decision, so it’s important to consider the pros and cons. It’s also a good idea to consult a financial advisor to guide your decision and walk you through the process. If you prefer not to deplete your 401(k) savings, you could refinance to reduce your payment or make extra payments toward your balance.

Think you might want to refinance? Learn how to refinance with Rocket Mortgage^® and save.

This article is for informational purposes only and is not intended to provide financial, investment, or tax advice. You should consult a qualified financial or tax professional before making decisions regarding your retirement funds or mortgage.