Pay off the mortgage?
Question: Take the extra money and pay off your current mortgage. You are then getting a >guaranteed return of your current interest rate, WITH NO RISK!
This is not true; there is always risk in anything you do.
Probably the biggest risk is illiquidity. Pre-paying your mortgage increases your home equity, but it’s difficult to access that asset. You run the risk that, if you need to access that money, you’ll have to take out a home equity loan which is more expensive (additional closing costs, higher interest rate, etc.) than your original mortgage. If the reason you need the money is because of income loss, you may have difficulty finding a lender if you don’t have any way to pay the loan back. Another risk is insufficient diversification. If your home performs poorly as an investment, you don’t have anything else to balance out your performance. If your home is damaged, destroyed, or otherwise greatly reduced in value your options for a bankruptcy discharge are reduced.
Answer: Take out a home equity line of credit now, not a home equity loan when you suffer income loss (i.e. lose your job). If you have equity in your home and times are good (i.e. you are working) it is not difficult to establish a home equity line of credit, they cost as little as $25 per year. IMHO that is cheap insurance, you simply don’t use it if you don’t need it. Sure if you have to draw on the home equity line of credit the amount you owe on your home will go up, but the theory is that it is better for the amount you OWE to go up because you NEEDED to use the equity as opposed to having the amount you owe up becasue you have large sums sitting next to idle in your bank account for the sake of liquidity.
If this doesn’t make sense or them is some flaw in my logic please let me know. If your home performs poorly as an investment you still have to pay off the mortgage. Though your point concerning diversification is a good one.
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Filed under: Home Equity Loan
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