Usually, it is good to pay off debts as quickly as possible. But is that the same with a mortgage? Some claim that you should pay off your home early, even in tough times. There are many benefits to paying off your home early. But many homeowners become overly excited about taking the final steps to truly own their home that they overlook some issues they could face by paying their mortgage early. This is amplified even further when people face hard times because of uncertainty.
The answer is very complex as to whether you should pay off your home early, especially during a recession. Aiming to pay off your home early should relieve you of your debt and allow you to actually own your home. However, aiming to pay off your home early can put you in a financial predicament, especially during a recession, that may even make you lose your house even with a tiny slip up.
I will explain if you should pay off your home early during a recession.
Advantages Of Paying Your Mortgage Off Early
One of the clearest advantages of paying your mortgage off early is the lack of a mortgage payment. You no longer need to make large monthly payments just to stay in the house. Now you only need to worry about upkeep, insurance, and property taxes. These are irritating, but otherwise smaller payments for homeownership.
While taking out a mortgage makes you feel like a homeowner, you are not the true homeowner. The creditor you borrowed from has a lien which is a legal document saying that you owe them money for the mortgage. That lien essentially gives the creditor and even contractors some rights to the property you took a mortgage on. Those rights taken are one of the things that keep you from being a true homeowner and the creditors frequently withhold the title of the property in this case.
When you pay off your mortgage the title (should, not always) transfers over to you. Then you withhold all of the rights of a homeowner. In other words, you do not really have the title as a homeowner until you have the legal title. I am pretty sure that is why they call it that.
With those rights, you can sell the house with fewer obstacles and even do more with your house including but not limited to certain remodels. You would be surprised how similar the restrictions are for what you can do on a house you mortgaged to the restrictions of what you can do on a home you rent.
With that in mind, it is no wonder most home mortgage takers are excited and even aim to pay off the mortgage.
Disadvantages To Paying Off Your Home Early
Unfortunately, attempting to pay off your mortgage early can lead to financial disaster.
Lack Of Retirement Funding And Diversification
One of the most common issues is a lack of retirement funding and diversification of assets. Or more commonly phrased: house rich, cash poor. One of the issues with paying more mortgage than you should is you have eliminated at least some of the money you have that could have been used for saving or investing. Therefore, more of your income is going to your house.
Some say that a house is an asset. Many argue that a house is not an asset, but a consumer good. Those who argue that it is an asset point out that a house is a non-liquid asset. That means it cannot be turned into a source of money readily. Even the best housing sales take months to finalize. And at that point, you may or may not be able to sell for a profit, especially if you have no other income to fall back on. Either way, it is not the source of money you may hope for.
Therefore, paying off your house early without otherwise diversifying your assets is putting all of your eggs in a basket that at best is a non-liquid asset. At worst, it is just a consumer good. Unfortunately, this is a common issue, even when just taking on a mortgage.
Lack Of Cash In An Emergency
One of the most financially lethal myths ever told is that home equity is like a savings account. It is not. Home equity can at most be used as collateral to take out a loan. It may take a long time to get any money from your home equity, sometimes your creditor can even deny you the ability to tap into home equity.
Many people can try to build home equity at the expense of available cash because of this myth. If they find themselves in an emergency they may need to rely on the liquidation of assets instead of liquid cash, which may be more costly than a mortgage’s APR.
In addition, practically every second mortgage will have higher fees and APR than a mortgage. Even if second mortgages were more liquid, they will cost more to pay off than simply making your minimum mortgage payments.
Too Much Equity During Tough Times Could Be Bad
Yeah, you read the headline right. If you have too much equity during tough times you may be a step away from disaster.
What type of house are creditors more likely to foreclose?
- One where the borrower makes late payments and has little equity and suddenly cannot make payments?
- One where the borrower pays on time, or early and has more equity and suddenly cannot make payments?
Logic states that the first borrower is riskier and that they should be foreclosed on instead of the borrower that pays of time. But why would you believe that? If both borrowers have faced an income shock and they are not making payments the risk of the borrowers makes no difference to the creditor’s income. The creditor is making the same amount of money from both borrowers.
However, the creditor can foreclose on the house where equity was built and make more money off of that foreclosure. The higher-risk borrower could be foreclosed on, but since the house has little equity, the creditor cannot make that much money foreclosing on it. The creditor may even lose money trying to foreclose of the higher-risk borrower’s house.
How Creditors Make Money
Creditors have other options including:
- suing the borrower for money.
Either way, the creditor makes more money when they have the low-equity borrowers keep the mortgage. Creditors will not make much money offering the same to higher-equity borrowers therefore, they are more likely to foreclose on the higher-equity borrowers.
It is not fair. However, a mortgage is a specific legal document that occasionally requires a lawyer. There are many clauses in which lawyers could recognize as unfair or risky so they can warn the borrower, and maybe even help in negotiations. Regardless, borrowers will not obtain a mortgage unless they agree to many terms that essentially promise creditors they will be paid the money they are owed one way or another. Creditors are loaning money with hopes to profit, if you take that away, creditors will not loan money.
You Cannot Miss Payments
Let us say you have lost a job and suddenly you cannot make the mortgage payments, typically, you can miss 4 payments. But that number varies and you could be foreclosed on even if you are making mortgage payments. So if you are trying to pay off your house early and you have built up twice as much equity as you would have with the minimum payments, you could be one or even fewer late payments away from being foreclosed upon. Your creditor may be waiting for you to make one slip up.
If you are uncertain about the future, you should not aim to pay off your mortgage early. In fact, if you are facing uncertain times, you should only make minimum payments on your mortgage. This is probably the only time I will say that about any debt.
What To Do Instead
Instead of using your extra money to pay off your mortgage early, you should save it. That way if you face an income shock, which is a reality for many people you can still make mortgage payments for a time so you can try to recover your income. As long as you make the mortgage payments, pay taxes, have insurance, and upkeep the property as according to the mortgage contract, your creditor will be making money and they (most likely) will not foreclose your house.
In addition, if you have extra money and sufficient savings for an income shock, you should look into investing. Granted, most mainstream investments are considered overvalued right now, there are still many other forms of assets you can look for that are not as overvalued. Furthermore, you can consider alternative investing, making a business, or freelancing. These can help form a stream of income that is not as dependent on broad markets as many mainstream assets such as stocks, bonds, even commodities.
Is There A Time To Pay Off A Mortgage Early?
Technically, paying off a mortgage early is financially wise. However, before you take on the endeavor, you should make sure your money is in line at other angles you have not considered.
- Do you have sufficient savings? You should have a minimum of 6 months of home mortgage expenses including upkeep, insurance, and taxes. Some even recommend more. When tough times arise it is accurate to say: this time things are different. While employment may be rising, many people are seeing that it is unlikely their old job may come back. And even if it does, the income from said job may not be as high.
- Do you have any other debts? If you have other debts, it is almost guaranteed they all have a higher APR than your mortgage. You will make more money paying off your higher-interest rate debts before your mortgage.
- Do you have a large purchase on the horizon? If you want to purchase something like a car or one of your child’s educations in the future it may be best to save up for that purchase. Trying to fund either with debt requires a loan with an APR higher than a mortgage’s APR.
- Do you have other streams of income? For many people a loss of a job is a loss of their entire income. Many people invest in assets, but only in retirement portfolios which are at the very least difficult to pull from to financially unwise to pull from. These investments are as non-liquid as a house if you are less than 59.5 in age. Income shocks happen to almost everyone so the question is: if you face an income shock, can you still make at least a good part of the mortgage payment without your largest source of income?
If you have taken on a mortgage, you do not truly own the property until you pay it off. Only John Mulaney has told me that proudly, most people hide this fact. It is a dream to finally say you actually own your home and only need to make the payments for taxes, insurance, and upkeep. Some even take extraordinary steps to pay off their house early.
That may be a mistake, even if the economy is good. Trying to pay off your mortgage early leads to:
- A lack of retirement funds
- A lack of diversity in assets
- Little cash immediately available
- Increased risk of foreclosure when the economy turns sour.
Homeownership may be a dream, but it can easily become a nightmare if you take it on with tunnel-vision. Wealth is not something that is forged just by focusing all effort into one area, but many areas. Make sure you focus on many areas of your finance before you try to become an official homeowner.