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

Owning your house outright has benefits. Your housing payment will be reduced significantly, you'll eliminate interest on your mortgage, you'll have 100% equity to cash in, and you can free up your cash for other financial goals -- like saving for retirement.

But here's a thought: If you have enough in your 401(k) to pay off your entire mortgage loan, would it be wise to do it? Or is it more prudent to let your money grow?

Truthfully -- there's not an easy, one-size-fits-all answer. If you're sitting on a hefty nest egg and want to eliminate the mortgage, let's take a look at when it makes sense and when you're better off leaving the money alone.

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

I can imagine two scenarios in which it makes sense to pay off your mortgage early with your 401(k).

In the first scenario, you're a young homeowner and have plenty of time to replenish your retirement accounts after you draw from them. In this case, withdrawing from your 401(k) could help you eliminate interest payments, saving a hefty sum over a long period. For instance, if you had a 30-year mortgage for $350,000 with a 6% interest rate and 10% down payment, you would pay around $365,000 in interest over the loan's life.

That said, withdrawing from your 401(k) when you're young isn't cheap. You'll pay a 10% penalty on any amount withdrawn before the age of 59 1/2, as well as income taxes. Both of these will affect how much you stand to gain from the early withdrawal. You might save money on interest, but the penalty and taxes could very well make it a poor financial move.

In the second scenario, you're already 59 1/2 and therefore won't pay the 10% penalty. In this case, paying off your mortgage now will greatly reduce your future housing payments. This could also reduce how much you need to save in order to live comfortably in retirement.

You won't need to replenish your retirement account per se, since eliminating your mortgage will reduce your monthly expenses. And you could save money on mortgage interest, thereby helping stretch your retirement savings further.

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.

When it doesn't make sense

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

Although it could work in some scenarios, the opportunity cost could come back to haunt you. Using money from your 401(k) to pay your mortgage means sacrificing compound interest in your investments.

Since a 401(k) lets you grow money tax free, this could mean leaving a lot of money behind just by paying your mortgage early. Depending on your age and income, it could also take a while for you to rebuild the 401(k) that you drained.

Again, there's no clear-cut answer. You might find that saving money on interest is more beneficial to you than the potential return on your investments. But do the math first.

Often, when I hear people talking about paying off their mortgage early with retirement savings, they say things like, "I just want the feeling of having no mortgage payment." I'm sure it's a great feeling to have no housing payment, but if it's not backed up by numbers, the sacrifice might be too great to justify the costs.