Refinancing your mortgage to a lower interest rate can save you thousands of dollars over the life of the loan. However, if you don't have the money to pay for the closing costs, or if you have seen your home's value fall to the point where you owe more than it's worth, you might miss out on the opportunity to save money with a refi. Before you give up hope, consider the options your 401(k) might provide in helping to refinance your home.
No Use as Collateral
Retirement accounts, such as 401(k) plans, can't be used as collateral, which means you can't offer to use your 401(k) plan to guarantee the loan. If you tried, lenders won't let you use your 401(k) plan as collateral because by law you're not permitted to sign it over. If the lender went to your 401(k) plan administrator and tried to seize your assets to pay off your loan, even if the lender had your signature saying it was collateral, the plan wouldn't let the lender take it.
Hardship Distributions Unlikely
Some 401(k) plans permit hardship distributions from the plan when you have an immediate and heavy financial need that you can't pay for with other sources of funds. Examples of hardship distributions occur when you need money to avoid eviction from your home or to pay for repairing damage to your home. The plan administrator makes the determination whether you qualify for a hardship distribution based on the language in your 401(k) plan. Unless you were refinancing your home to avoid eviction, it is unlikely that your refinancing costs would be considered an immediate and heavy financial need. However, if you are permitted to take a hardship distribution to help refinance your home, you have to pay an additional 10 percent tax, on top of your regular income taxes, unless you are 59 1/2 or older, because you are taking an early distribution.
Borrow From 401(k) Plan
If you need additional funds, your 401(k) plan might permit you to take a loan for any reason, including assisting in your home refinance. Check with your plan documents or plan administrator to see if loans are allowed. If you needed additional funds for closing costs, but your lender wouldn't let you borrow any extra, you could borrow the closing costs from your 401(k) plan. Alternatively, if your home had lost value and your lender wouldn't refinance until you paid down the amount you owed, you might be able to use a 401(k) loan to pay down the debt. However, check with your lender first because the mortgage lender might count your 401(k) loan as additional debt and further limit your refinancing options.
Limits on 401(k) Loans
If your 401(k) does permit loans, you have to stay within limits on how much you can borrow. Typically, you are restricted to $50,000 or half your vested account balance, whichever is smaller. For example, if you have $80,000 vested in your 401(k), you could borrow $40,000. However, if you have $250,000 vested in the account, you can only borrow $50,000. The loans must be repaid, with interest, over no more than five years, but the repayments get added to your account, so you are effectively paying yourself back with interest.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."