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Your Best Interest? Don’t Think So

June 30th, 2008

You see these schemes all the time — promoted by financial planners, savings institutions, and yes, lenders. It can feel like if you aren’t on some plan to pay off your mortgage early you’re missing the boat or being financially irresponsible.

Some motives are plain. These people actually charge you to set up an “early repayment plan — in one case $3,500 for a line of credit and some software. So they naturally want you to believe that paying off your mortgage early is a good thing and that only they can help you accomplish this. Just tell these sales guys you’ll pass, thanks very much.

The next group of perhaps well-meaning “advisors” is simply very conservative with investing and the type of risk involved. But there is risk involved with every investment decision. Most economists will tell you that a company or a household is actually healthier financially when they are carrying a reasonable amount of debt and when the funds are used for investing in assets (like maybe a house? mutual funds? college?) that grow and pay off later. By putting everything into your home and leaving no extra for investing you have “all your eggs in one basket,” and as we have seen recently┬áthat’s not always safe or prudent. Keep in mind also that unless you have no other debt you are probably better off paying debt that doesn’t offer any tax advantages and carries higher interest rates.

The final group of those egging you on to pay off your loan early are lenders. They have two reasons for this. First, the more equity you accrue in your home the safer the loan is for the lender. Think a “cushion of equity” is going to protect you from foreclosure if you lose your job? NO, it makes it easier for the institution to recover its investment by foreclosing and therefore LESS likely that it will be willing to work things out with you. Safer for the bank, less safe for you.

Additionally, once you put your money into paying down your mortgage early–whether it’s making an extra payment each year, making payments every 2 weeks, paying a few extra dollars each month, or any other scheme–you no longer have instant access to that money. Guess what? If you need it, your bank will charge you to get your money back out of the home, in the form of fees for a home equity loan or line of credit.

So how do you accomplish the goal of paying off your mortgage early? Simply by taking whatever extra you are planning to throw at the principal balance but putting it into an investment account instead. There are planty of safe, conservative investment vehicles available for risk-averse or older homeowners. Younger ones can afford to go for higher risk / return strategies. Talk to an investment advisor about a plan that incorporates your goals and your comfort zone. With this plan, you have access to the extra funds without paying, your lender has less leverage should you experience financial difficulties, and when you are ready to pay off the whole shebang you can do it with the funds you have invested.