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Mailman9, you lost me.

You will reduce the returns in your 401(k) plan, but, you'll increase the equity you'll have in your home.

But her net worth will still be the same. She'll have more "home equity" and less "401k equity." In either case, she buys a house and takes on a debt that has to be repaid.

That money will not be taxed

It depends on what you mean by that...her loan principal (not the interest) will be paid will after-tax dollars whether she borrows from her 401k or from a mortgage lender.

and, most likely, the income (in the form of increased value in your house) will not be taxed either (if you meet the requirements for the $500,000 exclusion by living there for at least two years)

It doesn't matter whether phoebesnow finances 0% or 100% of the purchase price of her home. She is entitled to all of the profit and walks off with the exact same amount of tax-free gain (sales price minus acquisition costs) when she sells her house in either case.

Making your mortgage smaller doesn't earn you one extra penny when you sell. You are investing in "having a smaller mortgage" rather than investing somewhere else...whether that's a worthwhile investment is up to you.

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