So, we hear all the time from financial pundits, "Invest in your home. Pay off mortgage early. Home equity is safe and liquid." Conventional wisdom tells us your home is an asset. Since you live in the home, the equity is safe and available to you. Pay off your mortgage as fast as you can so you can avoid paying interest. Accelerate the payments.
Of course, we're here to challenge those statements. Imagine I am your financial advisor. I have an investment opportunity I want to present to you. Let me tell you of the following "features".-You can determine the amount of monthly contributions and length of time for each of the contributions to continue.
-You can pay more than the minimum monthly contribution, but not less.
-If you attempt to pay less, the financial institution keeps all of the previous contributions.
-The money in the account is not liquid.
-The money deposited in the account is not safe from loss of principal.
-Each contribution made to the account results in less safety of the principal.
-The money deposited in the account earns zero percent rate of return.
-Your income tax liability increases with each new contribution.
-When the plan is fully funded, there is no income paid out to you.
(The components of this investment were derived from Missed Fortune 101 by Douglas R. Andrews.)
So, how does that sound? Have you fired me yet?
Because of the unappealing features, most would instantly reject this kind of investment. However, if you have a traditional mortgage, then you've already bought into the investment detailed above. We'll refer to this as your Pay Off Mortgage Strategy.
Let's look into these features of a traditional mortgage further. Let's make it interesting; let's keep score.
The Traditional Mortgage
To lay the foundation, the traditional mortgage is a 30 year amortized loan. At the end of the term, 30 years, you own the home outright. Now, onto the things this investment offers...
You can determine the amount of monthly contributions and length of time for each of the contributions to continue.
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| Pay Off Your Mortgage - The Strategy That Could Be Your Worst Financial Move |
In our example, the term is 30 years. However, many homeowners want to pay it off sooner and look to the 15 year mortgage (the Pay Off Mortgage Earlier Strategy). Regardless, it is you that determines the amount and length of the loan by selecting the loan options offered to you by the financial institution. Once you select, it's set.
Pay Off Mortgage Strategy: +1
You can pay more than the minimum monthly contribution, but not less.
Now that you've selected, your mortgage, you are allowed to pay more than the minimum monthly amount (how gracious of the bank). What many don't consider is that you can't pay less. Remember, it's a binding contract so you must abide by the terms set by the financial institution.
If you are currently making more than the minimum monthly payment, you are effectively saying, "Here you go Mr. Banker. No, I don't want to earn a rate of return on this money. But if I ever want it back, I would like to prove to you that I need it for a reason you deem worthy, can repay it, and on your terms." Crazy isn't it?
Pay Off Mortgage Strategy: -1
If you attempt to pay less, the financial institution keeps all of the previous contributions.
If you miss three payments, the mortgage lender has the power to foreclose on your home.
I know individuals that tell me to pre-pay my mortgage or have bought into the strategy. Most don't realize that pre-paying your mortgage this way is risky. Why? Because...
It doesn't matter if you have:
Doubled up your payments for 10 years...
Put 80% down as a down payment...
Or, have one year left on the mortgage...
...The next payment is always due. If you don't pay, then you are increasing the risk of foreclosure...and ultimately the home equity you may have locked into your home. Could the American Dream cause a nightmare?
Pay Off Mortgage Strategy: -1
The money in the account is not liquid.
Home equity is not liquid. It's trapped into the mortgage of the home. In order to access the cash that is in the form of home equity, you would either have to sell the property or refinance.
Let's look at a possible scenario. Let's say that you have experienced a downturn in the economy and you have lost your job. Unfortunately, you need to access the equity in your home in order to sustain your current lifestyle. Now, you have to prove to the financial institution that you need it and can repay the loan. But chances are, your ability to repay doesn't look good. Remember, you're unemployed. Banks only lend money on the fact that you have the ability to repay.
And why shouldn't they? I think we would all take the same stance and only loan money on the ability of the other party to pay it back.
You would not have this problem if your "home equity" was separate in a liquid account.
Pay Off Mortgage Strategy: -1
The money deposited in the account is not safe from loss of principal.
Let's say that Person A owns his $100,000 outright. There is no mortgage. Person B has the same home down the street but has $80,000 of equity separate in a liquid fund and only $20,000 trapped in the mortgage.
The housing market in that area decreases 30%.
Since Person A has all his money in his home in the form of equity, he has just lost 30%. Person B's house value dropped the same amount as well. However, he still has $80,000 of "equity" in his liquid fund. Who's in a better position?
I know what you're thinking: "But Person B has a mortgage!". Sure, he has a mortgage. But don't you think he can be more productive with that $80,000 in a liquid account than in the house losing value?
Pay Off Mortgage Strategy: -1
Each contribution made to the account results in less safety of the principal.
As mentioned, the amount of equity plays no part in determining the the value of your home.
If you have a lot of equity in your home and you are facing foreclosure, it may be a primary target for your bank. Who do you think a bank would want to foreclose on first: a home with equity or a home that is mortgaged to the hilt? It would be a home with equity because they are able to recapture their losses faster.
Pay Off Mortgage Strategy: +1
You can pay more than the minimum monthly contribution, but not less.
Now that you've selected, your mortgage, you are allowed to pay more than the minimum monthly amount (how gracious of the bank). What many don't consider is that you can't pay less. Remember, it's a binding contract so you must abide by the terms set by the financial institution.
If you are currently making more than the minimum monthly payment, you are effectively saying, "Here you go Mr. Banker. No, I don't want to earn a rate of return on this money. But if I ever want it back, I would like to prove to you that I need it for a reason you deem worthy, can repay it, and on your terms." Crazy isn't it?
Pay Off Mortgage Strategy: -1
If you attempt to pay less, the financial institution keeps all of the previous contributions.
If you miss three payments, the mortgage lender has the power to foreclose on your home.
I know individuals that tell me to pre-pay my mortgage or have bought into the strategy. Most don't realize that pre-paying your mortgage this way is risky. Why? Because...
It doesn't matter if you have:
Doubled up your payments for 10 years...
Put 80% down as a down payment...
Or, have one year left on the mortgage...
...The next payment is always due. If you don't pay, then you are increasing the risk of foreclosure...and ultimately the home equity you may have locked into your home. Could the American Dream cause a nightmare?
Pay Off Mortgage Strategy: -1
The money in the account is not liquid.
Home equity is not liquid. It's trapped into the mortgage of the home. In order to access the cash that is in the form of home equity, you would either have to sell the property or refinance.
Let's look at a possible scenario. Let's say that you have experienced a downturn in the economy and you have lost your job. Unfortunately, you need to access the equity in your home in order to sustain your current lifestyle. Now, you have to prove to the financial institution that you need it and can repay the loan. But chances are, your ability to repay doesn't look good. Remember, you're unemployed. Banks only lend money on the fact that you have the ability to repay.
And why shouldn't they? I think we would all take the same stance and only loan money on the ability of the other party to pay it back.
You would not have this problem if your "home equity" was separate in a liquid account.
Pay Off Mortgage Strategy: -1
The money deposited in the account is not safe from loss of principal.
Let's say that Person A owns his $100,000 outright. There is no mortgage. Person B has the same home down the street but has $80,000 of equity separate in a liquid fund and only $20,000 trapped in the mortgage.
The housing market in that area decreases 30%.
Since Person A has all his money in his home in the form of equity, he has just lost 30%. Person B's house value dropped the same amount as well. However, he still has $80,000 of "equity" in his liquid fund. Who's in a better position?
I know what you're thinking: "But Person B has a mortgage!". Sure, he has a mortgage. But don't you think he can be more productive with that $80,000 in a liquid account than in the house losing value?
Pay Off Mortgage Strategy: -1
Each contribution made to the account results in less safety of the principal.
As mentioned, the amount of equity plays no part in determining the the value of your home.
If you have a lot of equity in your home and you are facing foreclosure, it may be a primary target for your bank. Who do you think a bank would want to foreclose on first: a home with equity or a home that is mortgaged to the hilt? It would be a home with equity because they are able to recapture their losses faster.
 |
| Pay Off Your Mortgage - The Strategy That Could Be Your Worst Financial Move |
You'll find that banks are willing to work more with the customers that have less equity.
Pay Off Mortgage Strategy: -1
The money deposited in the account earns zero percent rate of return.
Using the same example of the $100,000 homes for Person A and B, let's imagine that the housing market is booming and the houses in the area appreciated 30%. How much is Person A's house? $130,000. How much is Person B's house? $130,000.
Why are they the same? It's because home equity has no rate of return.
The homes appreciated in value. The home equity had nothing to do with it. But let's see who did better with his money?
With the $100,000 locked into his house, Person A's asset grew 30% ($30,000) on his money. Not bad.
Remember, Person B has only 20% home equity in his house. With the $20,000 locked into his house, Person B's asset grew a whopping 150% ($30,000) on his money. Even better!
Which scenario do you like? But remember, none of that growth can be accessed until the time of sale or refinance.
We haven't even touched on the fact that Person B has $80,000 in a liquid account that can be earning interest!
Pay Off Mortgage Strategy: -1
Your income tax liability increases with each new contribution.
Mortgage interest is your friend. What? Mortgage interest is good?
Let's look at two types of interest: non-deductible and deductible.
Credit card interest is non-deductible. You don't get tax advantages when you pay interest on consumer debt.
Mortgage interest, on the other hand, is deductible. Let's say that the interest you pay on a mortgage is $6,000. If you are in the 33.3% tax bracket, your true cost is only $4,000. Deductible interest is better than non-deductible interest.
As you continue to pay down your traditional loan, you decrease this valuable tax deduction. Of course, it isn't wise to incur an interest expense for the sake of a tax deduction. But, remember which is preferred: deductible interest.
Pay Off Mortgage Strategy: -1
When the plan is fully funded, there is no income paid out to you.
This is pretty self-explanatory. Your house doesn't pay you. There is no cashflow. Yes, you no longer have a mortgage. But remember, the money sitting in your house is only doing one thing. Can you think of other productive ways to use that home equity?
Again, you can only realize that equity at the time of sale or refinance.
Pay Off Mortgage Strategy: -1
Bonus (sort of): Home equity is not protected from lawsuits and creditors.
If you own your home under your name, your home equity can be at risk if you are sued. The value is not protected. I don't like to be a downer, but we live in a litigious society today. Frivolous lawsuits are common. The more cash that's in your house, the bigger target you may have on your back.
Pay Off Mortgage Strategy: -1
Okay, let's address the real reason why people want to pay off their mortgage early. When you "own" your home, you of course have no more mortgage. And that's what people hate, having to make those payments.
What we have to realize is that everything has a consequence. It's the Law of Cause and Effect. Not having a monthly payment may be a good thing. But now you should be aware of the risks of paying off your mortgage in the traditional fashion. Is it worth it? Is there a better way?
Pay Off Mortgage Strategy Score Total: (It doesn't matter what I think. You decide.)
This way of thinking about your mortgage may be new to you. I'm sure that some of you are experiencing a knee jerk reaction: "No, pay off mortgage early!"
It's not difficult to see why this thinking is prevalent. My parents and my wife's parents own their homes outright. Of course we were taught by them that this was the best way to pay for and own a home.
Pay Off Mortgage Strategy: -1
The money deposited in the account earns zero percent rate of return.
Using the same example of the $100,000 homes for Person A and B, let's imagine that the housing market is booming and the houses in the area appreciated 30%. How much is Person A's house? $130,000. How much is Person B's house? $130,000.
Why are they the same? It's because home equity has no rate of return.
The homes appreciated in value. The home equity had nothing to do with it. But let's see who did better with his money?
With the $100,000 locked into his house, Person A's asset grew 30% ($30,000) on his money. Not bad.
Remember, Person B has only 20% home equity in his house. With the $20,000 locked into his house, Person B's asset grew a whopping 150% ($30,000) on his money. Even better!
Which scenario do you like? But remember, none of that growth can be accessed until the time of sale or refinance.
We haven't even touched on the fact that Person B has $80,000 in a liquid account that can be earning interest!
Pay Off Mortgage Strategy: -1
Your income tax liability increases with each new contribution.
Mortgage interest is your friend. What? Mortgage interest is good?
Let's look at two types of interest: non-deductible and deductible.
Credit card interest is non-deductible. You don't get tax advantages when you pay interest on consumer debt.
Mortgage interest, on the other hand, is deductible. Let's say that the interest you pay on a mortgage is $6,000. If you are in the 33.3% tax bracket, your true cost is only $4,000. Deductible interest is better than non-deductible interest.
As you continue to pay down your traditional loan, you decrease this valuable tax deduction. Of course, it isn't wise to incur an interest expense for the sake of a tax deduction. But, remember which is preferred: deductible interest.
Pay Off Mortgage Strategy: -1
When the plan is fully funded, there is no income paid out to you.
This is pretty self-explanatory. Your house doesn't pay you. There is no cashflow. Yes, you no longer have a mortgage. But remember, the money sitting in your house is only doing one thing. Can you think of other productive ways to use that home equity?
Again, you can only realize that equity at the time of sale or refinance.
Pay Off Mortgage Strategy: -1
Bonus (sort of): Home equity is not protected from lawsuits and creditors.
If you own your home under your name, your home equity can be at risk if you are sued. The value is not protected. I don't like to be a downer, but we live in a litigious society today. Frivolous lawsuits are common. The more cash that's in your house, the bigger target you may have on your back.
Pay Off Mortgage Strategy: -1
Okay, let's address the real reason why people want to pay off their mortgage early. When you "own" your home, you of course have no more mortgage. And that's what people hate, having to make those payments.
What we have to realize is that everything has a consequence. It's the Law of Cause and Effect. Not having a monthly payment may be a good thing. But now you should be aware of the risks of paying off your mortgage in the traditional fashion. Is it worth it? Is there a better way?
Pay Off Mortgage Strategy Score Total: (It doesn't matter what I think. You decide.)
This way of thinking about your mortgage may be new to you. I'm sure that some of you are experiencing a knee jerk reaction: "No, pay off mortgage early!"
It's not difficult to see why this thinking is prevalent. My parents and my wife's parents own their homes outright. Of course we were taught by them that this was the best way to pay for and own a home.
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