Raiding Your 401(k) to Refinance

You want to refinance your mortgage loan to take advantage of low interest rates. This makes sense. By lowering your mortgage interest rate you could shave hundreds of dollars off your monthly mortgage payments. Unfortunately, you don't have enough equity in your home to refinance. You might be tempted to raid your 401(k) account at work to help pay down the balance of your loan and boost your equity, but doing so is a risky -- and potentially costly -- move.

Equity

Most mortgage lenders today require homeowners to have at least 20-percent equity in their homes before they'll grant them a refinance. This can be a problem. If your home has lost value since you purchased it, you might not have the 20-percent equity you need for a conventional mortgage refinance.

Tapping Into Your 401(k)

You might be tempted to take an early withdrawal from your 401(k) plan and use that money to pay off a significant chunk of your mortgage loan's principal balance. This would increase your equity because you are reducing the amount of money you owe on your mortgage loan.

The Challenge

Taking this step can prove challenging. The Internal Revenue Service says that homeowners can only take an early withdrawal from their 401(k) accounts to help purchase a first home or to prevent losing their home to foreclosure. You might be able to take a "hardship withdrawal" from your 401(k) account if you can prove that you are in danger of falling into foreclosure. You won't be able to withdraw dollars from your 401(k) plan if you just want to take money out of it to qualify for a refinance and are not in danger of losing your home.

Withdrawal Penalties

Even if you are able to withdraw funds from your 401(k) plan to reduce your mortgage principal, you might think twice about doing so. Such a move comes with a significant financial penalty. You'll have to pay taxes on the money you withdraw, and also have to pay a penalty of 10 percent of the money you take out of your account.

Borrowing From Your 401(k)

Some companies -- but not all -- allow employees to borrow from their 401(k) plans. If your company allows this, you'll generally be able to borrow as much as half of the money in your 401(k) up to a limit of $50,000. You will have to pay this money back with interest; usually, companies allow employees five years to do so. You should think carefully about using your 401(k) money for this purpose, though. If those dollars aren't sitting in your 401(k) account, they're not compounding, and that can cost you future retirement savings that might far outweigh the savings you'll receive by refinancing.