On pre-paying your mortgage, bit-by-bit. You might agree it’s not a good idea!
A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain.
-Attributed to Mark Twain
When you obtain a mortgage from any lender (notably banks), you will often receive “the letter”.
What is “the letter”? It states:
“Congratulations on the financing of your home, and welcome aboard as a client of our bank. We have a suggestion to make your purchase ultimately more affordable: whenever possible, send us an additional payment. In so doing, you will decrease the length of time required to completely pay your mortgage, and you will save many dollars in interest expense.”
Now, who can argue with that? We can.
First, you should be aware that everything we purchase, rent, or pay down is associated with “opportunity cost”. Every penny we spend, etc. is the result of our decision to use that money for that moment’s purpose. So, are you “saving” on interest? Perhaps you are, but what could the money be used for, or how could it grow, instead? Would that offset, even overwhelm, the expense?
Second, remember when you applied for the mortgage? The bank researched you as a borrower; that is, are you a good risk? Yes, the bank took you on as a risk, and loaned you money.
It is entirely reasonable that you might feel better not owing money on your home, and so attempt to get out of debt as soon as possible. Occasionally sending the bank an extra check will certainly shorten the pay-back time, but it will also decrease the bank’s risk, and increase yours.
Conventional wisdom suggests that if you add those payments, you will have more equity in your home, and if you need the cash, you’ll know where to find it. You will simply get a Home Equity loan or re-finance, freeing up your equity.
Here’s the key question: why might you need the cash?
Is there a possibility that, in the future, you could be unemployed? Under-employed? Ill? Disabled?
Now, again, remember when you applied for the mortgage? The bank was concerned about your income, right?
If, upon “need” as suggested above, you approach the bank to apply for a loan to access that locked-in cash, the bank will ask for your current income data. Unemployment or disability will likely impact income, and thus your trip to the bank!
In other words, unemployed, unhealthy, in-need…even short-term, you’re not likely to get the cash you need. The bank will likely view you as a poor risk for the new loan request.
Could any of these negative “events” happen to you? Well, life happens, doesn’t it?
So, if you made additional payments, the bank will overlook those additional contributions, possibly even thank you for them, and continue to act like a bank (i.e. foreclosure?). Key Point: you will have decreased the bank’s risk and increased your own.
Here’s an alternative: when you have additional monies to send to the bank, don’t. Instead, put the money in a vehicle that you have control over, such as a savings account, CD’s, Whole Life insurance, etc. Look for a vehicle with little or no risk. As you build this account over time, the earnings may actually offset the interest expense the bank teased you with (aka mortgage interest cost), but it will certainly help to manage your family’s risk. When the money is available to pay off the mortgage in full, then (and only then) should you decide if that is right for you.