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Using Your 401(k) to Pay Off Your Mortgage

Byline profile imageWritten by Andrew J. Dehan
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Byline profile imageEdited by Becca Stanek
Byline profile imageEdited by Arturo Conde, CEPF®
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The government offers several incentives for retirement accounts like 401(k)s. For example, they’re a tax-deferred investment, meaning you won’t pay taxes on them until you withdraw. 401(k) deposits also don’t count as taxable income during the year that you make them, so you can use them to lower your tax liability. Just as they incentivize retirement investment, the government penalizes people who withdraw early. But in some scenarios, it may make sense to dip into your 401(k) early. One of these scenarios is to pay your mortgage. Before deciding to take money out of your retirement fund to pay for your mortgage you should weigh the pros and cons. You may also want to get expert advice from a financial advisor about your specific situation. 

Should You Pay Off Your Mortgage With Your 401(k)?

Paying your mortgage off can feel like a relief, especially if the debt hurts your mental health. But you don’t want to make this decision solely on that emotion. Your retirement is your nest egg. Before you dip into your retirement savings, there are four questions you need to answer.

1. How Old Are You?

If you’re under the age of 59 ½ , you’ll face a 10% penalty for making a withdrawal from your 401(k) before retirement age. That penalty is a huge blow to the funds you’d actually end up getting from your withdrawal—and an argument against tapping the account for your mortgage payoff. As an example, if you were to take out $50,000 to pay down the mortgage, you’d automatically pay a penalty of $5,000. That’s before taxes, too, so your actual cash-in-hand would be even less.

2. How Much Do You Owe?

How much you owe on your mortgage factors into your decision in a couple of ways. For example, let’s say you owe $200,000 on your mortgage. If you pay off your mortgage, not only would you not have to make the mortgage payment, but you’d also avoid paying interest on $200,000. However, if you take $200,000 out of your 401(k), you’d have to pay tax on the distribution. For $200,000, this could result in owing thousands in taxes. 

To see whether the withdrawal actually would make financial sense, estimate the taxes you’d pay on your 401(k) withdrawal and weigh those against the interest you’re paying on your mortgage.

3. How Much Have You Saved?

Depending on the size of your nest egg, paying off your mortgage with your 401(k) could make sense. However, consider using your other savings or assets first. If you need to stretch your 401(k) into retirement, it may make more sense to keep the funds in it invested and use other assets to pay down your mortgage.

4. What’s Your Expected Rate of Return?

This is a big one. If your 401(k) is reliably delivering a 7% rate of return, you should think long and hard before touching it. That rate of return is free money. 

For example, if you have $1 million in your 401(k), at 7% annually, that’s earning you $70,000 a year. As you dip into your 401(k), however, this annual payment will shrink. If you take $300,000 out to pay off your mortgage, your annual growth will go from $70,000 down to $49,000.

Pros of Paying Off Your Mortgage With Your 401(k)

Using your 401(k) to pay off your mortgage can reduce your retirement savings and future growth.

When you pay off your mortgage, regardless of the method, it can feel like you finally have  breathing room in your finances. Here are some of the upsides to zeroing out your mortgage balance to consider in your decision-making process:

  • Lower monthly costs: There’s something to be said about not having to pay your mortgage every month. If your mortgage payment is $2,500 a month, that’s $30,000 every year you don’t need to worry about shelling out. If you’re on a fixed income, eliminating this expense could drastically reduce your regular costs.
  • Avoided or reduced interest payments: By paying off your mortgage early, you’ll cut down on the total interest you’d pay. For instance, with a 30-year fixed-rate mortgage of $400,000 at 7% interest, you’d pay $558,035.59 in interest alone over that 30 years. The younger your mortgage is, the greater the impact of interest, too Because of the way mortgages amortize, borrowers pay the interest owed up front, gradually paying more of the principal over the loan term. If you’re in the final five years of your 30-year mortgage, you’ve already paid most of the interest. But if you’re in the first five years of your mortgage, you still have most of the interest ahead of you.
  • Estate planning security: Owning your home in full can make matters easier for your heirs. When estate planning, you may decide to pay off your mortgage so your heirs receive your home at full value. As you near the end of your life, owning the home outright can protect the asset for those you’re leaving it to.

Cons of Paying Off Your Mortgage with Your 401(k)

Using your retirement funds comes with some serious drawbacks to consider before moving forward:

  • Reduced retirement assets: Paying off your mortgage with your 401(k) can significantly eat into your retirement assets, especially if you have a large mortgage balance left to pay. For instance, if you’re paying off a $200,000 mortgage and you have $1 million in retirement savings, that’s 20% of your retirement.
  • Loss of potential growth: If your 401(k) earns 7% a year, taking money out to pay off your mortgage reduces future growth. That lost growth can affect how much you’ll have when you retire.
  • Sizable tax bill: Perhaps one of the biggest deterrents to paying off your mortgage with a 401(k) is the hefty tax bill that will result. Remember, all of the money you withdraw from your 401(k) is counted on your income taxes. So if you withdraw $200,000 to pay off your mortgage, you’re going to pay taxes on it. This could bump you up to another tax bracket, raising your effective tax rate. 

Alternatives to Using a 401(k) to Pay Off Your Mortgage

Before tapping into retirement savings, consider other ways to address your mortgage. If your goal is to reduce payments, refinancing to a lower rate or a shorter term can cut interest costs without touching your retirement funds. Making extra principal payments from regular income or other non-retirement savings can also accelerate payoff while keeping your 401(k) growing.

Another option is downsizing to a smaller or less expensive home. Selling your current property and using the proceeds to buy a cheaper one can eliminate or reduce your mortgage without triggering taxes or penalties from a 401(k) withdrawal. This approach can also lower ongoing costs like property taxes, insurance and maintenance.

Home equity loans or lines of credit may provide a bridge if you need funds for a specific expense. While they carry their own interest costs, they can be structured in a way that’s less damaging to your long-term financial position than a large taxable withdrawal from your retirement account.

Bottom Line

Alternatives for paying off your mortgage include using savings, refinancing, or making extra payments.

Paying off a mortgage with a 401(k) can make sense in specific scenarios. It removes the emotional weight of the debt, plus it can make things easier for your heirs when estate planning. However, you need to consider the cons carefully. You will end up paying taxes and you don’t want to dip into your retirement savings to the point of it affecting your quality of life.

Tips for Retirement and Mortgages

  • Want to create a financial plan that grows your money and provides for a secure retirement? You might benefit from talking to a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Use SmartAsset’s mortgage calculator to work out how much a new mortgage payment will be, see how the mortgage amortizes and how much interest you will pay throughout the loan.
  • Check out SmartAsset’s income tax calculator, you can estimate how much tax you will pay due to a large withdrawal from your 401(k).

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