Will be laid off 03/31/09. Age is 61. 401k is currently double my outstanding mortgage amount. Thinking about using the 401k to pay off mortgage and invest remainer in an IRA. What penalties or taxes will I be facing? Could the 401k funds be rolled into an account at the bank holding my mortgage and used to pay the mortgage each month thereby reducing or eliminating any penalty or taxes?
Logic for doing this is that I can then work part time and wait until 62 for social security.
Thank you for your help.

Why would you exchange a tax deduction for a tax liability? If you are retiring from your current job, at your age, you can probably avoid the 10% penalty. But you can probably earn more then you save by paying off the mortgage.