If you have a large 401 (k) plan but aren’t quite near retiring age, you may be considering using part of it to pay off your mortgage.
Seems like a good idea, but is it?
There is no “right” answer. Factors like how much you owe on your mortgage and your ability to pay back the amount you “borrowed” can affect your outcome. Just like any other financial decision, your best option is to find out the facts and weigh your options.
What is a 401 (k)?
401 (k) retirement plans offered by your employer. They’re meant to help you save for retirement on a tax-deferred basis. Your employer will also contribute to your savings. Although the money in there belongs to you, penalties will apply if you use your 401 (k) to pay off your mortgage.
To access the money in your 401 (k), you’ll need to move, or roll over, the funds from your employers plan into an Individual Retirement Account (IRA).
401(k) Rollover Penalties
You won’t have any penalties if you roll over your 401(k) into another authorized retirement account. However, if you’re younger than 59 1/2 and use the money to pay down your mortgage, these funds are now considered income and will have penalties.
In addition to the tax implications of extra income, you’ll also have a 10% penalty for withdrawing early from your 401(k).
Reduced Return on Investment
When you withdraw money from your 401 (K), you also reduce the amount it earns in interest. Taking out a few thousand may not affect the earning potential much, but withdrawing tens or hundreds of thousands of dollars can mean a significant reduction in your interest gains.
Some think that the home’s appreciation will make up for the loss, but this may not be true. Although home values are on an upward trend, investing your retirement in your home may be too risky.
Equity For Retirement
Buying property is still one of the best investments you can make, but when considering your retirement, your 401 (k) is more fluid. Remember, the purpose of your 401 (k) is to help you pay for everyday needs during retirement. That’s why makes more sense to use your 401 (k) savings rather than your equity savings for retirement.
Here’s another thing to consider: The cost of paying off a mortgage with favorable terms is relatively cheap when compared to the paying the penalties from an early 401 (k) withdrawal.
The Refinancing Solution
Although the final decision is yours, we often advise against using your retirement for paying down your mortgage –especially since there are alternatives!
You can lower your monthly payments by refinancing your mortgage to a better term. Or maybe you want to pay off your loan faster by getting a 15-year loan –either way, you win! You’ll lock in a great rate plus keep all of your retirement money.
Here’s another bonus: the money you save through refinancing can be applied toward growing your 401(k).