Should You Use Your 401(k) to Pay Off Your House?

Owning your house outright has its benefits: Your housing payment will be reduced significantly, you'll have 100% equity to cash in, and you can close faster when you sell since your lender will no longer be involved in the transaction.

But here's a dilemma: If you have enough money in your 401(k) to pay off your entire mortgage loan, should you do it? Or is it wiser to leave money invested and pay your mortgage off slowly over time?

Truth is: there's not a correct answer. Let's take a look at when it would make sense to pay off your mortgage with a 401(k) withdrawal and when you're better off leaving the money in your retirement accounts.

When it makes sense to pay off your mortgage with your 401(k)

In general, it makes the most sense to pay off your mortgage with your 401(k) when the interest you owe on your mortgage exceeds the earnings you expect to make on your investments. This isn't always easy to determine. But you might find yourself in this situation if you're early in your mortgage and still haven't paid the bulk of interest to your lender.

For example, let's say you took out a 30-year mortgage on a $450,000 home in January 2023, with a 30% down payment ($135,000) and a mortgage rate of 7.5%. The total interest you'll pay on this $315,000 loan is $478,428. Between January and May, you paid roughly $7,870 in interest, which leaves $470,558 unpaid.

Let's also assume your 401(k) contains $350,000 invested in 30-year Treasury bonds with an interest rate of 4%. If we include your earnings on bonds ($14,000), you'll pay roughly $7,574 this year in interest, which breaks down like this:

• Total interest paid in 2023: $21,574
• Total bond earnings for 2023: $14,000
• Difference: $7,574

Let's assume nothing changes for 30 years: You have the same mortgage rate, and the government doesn't default. Over 30 years, your bond earnings would cancel out a significant portion of your mortgage interest, but you would still pay roughly $58,428 more in interest than the return on your bonds ($478,428 − $420,000).

Now, there are a lot of variables overlooked here: you could refinance your mortgage, invest in stocks with higher rates of return, or sell your house. Plus, you have to pay a 10% penalty if you withdraw from your 401(k) before the age of 59 ½ and a massive withdrawal will put you in a higher tax bracket -- both of which could narrow your margins.

But my point is simply this -- for certain home buyers, the math may justify withdrawing money from your 401(k) to pay off your house, even after factoring in taxes and withdrawal penalties.

In general, this might be true if you have a relatively long time horizon and can use freed up cash flow to replenish your 401(k). Or it could be true if your rate of return on investments is low but your mortgage rate is high.

When it doesn't make sense

I'll go ahead and say it: For most home buyers, the math likely doesn't justify using your 401(k) to pay off your mortgage.

For one, you could pay a significant amount for penalties and taxes. The penalty for withdrawing before you're 59 ½ is 10% of the withdrawal amount. For the example above, you would have to pay $35,000 simply for withdrawing $350,000. Additionally, you have to add the $350,000 to your taxable income, which could lead to a hefty tax bill.

But by far the largest cost to you is opportunity. Selling off 401(k) investments means forgoing future returns. It can also mean missing out on the market's best days, which, according to a study by Fidelity, could mean sacrificing hundreds of thousands in potential earnings.

Should you pay off your house with your 401(k)?

Regardless of the math, you might want to pay off your mortgage with a 401(k) if you're nearing retirement and want to lower your monthly housing costs. Likewise, if debt stresses you out, you might save your mental health by owning your home outright and eliminating the possibility of a foreclosure.

But I strongly recommend doing the math first. See if it saves you money over the long run, or if the sacrifice is simply too great to justify the costs.