Why Paying Down Your Mortgage is More Important Than Ever

By Kevin M

What’s old is new again—there is risk in carrying a mortgage on your home! The foreclosure wave and forced short sales of the past few years have shown that paying down—and ultimately paying off—your mortgage isn’t just desirable, but perhaps even a completely necessary step toward securing you financial future.

The risk of not paying off your mortgage

The people who are in the biggest hole right now aren’t the ones who’s property values dropped so much as the ones where the value dropped below the amount of the mortgage securing the property.

Let’s say we have two neighbors, each owning a near identical home worth $200,000. Home Owner A has a $50,000 mortgage on his home, while Home Owner B owes $180,000. A recession hits, bringing a 25% drop in home values, and lowers the value of each home owners property to $150,000.

Home Owner A may find the price drop disturbing, but unless he plans to sell the home to fund his retirement in the near future, his financial situation is largely undisturbed. Even if he loses his job or is hit by some sort of financial calamity, because he has equity in his home he has the ability to sell it to pursue what ever paths he may need to.

Home Owner B on the other hand, has a real problem. He now finds himself carrying a debt load of $180,000 on a property now worth only $150,000. If he’s forced to sell for any reason, he will not be able to close without writing a check—in this case a very big check which will probably only make his situation worse. Home Owner B is symptomatic of the distressed home owner who is highly likely to lose his home in foreclosure.

Since we now know that home prices can go down as well as up, the best strategy to deal with this possibility is to steadily and relentlessly work to pay down your mortgage.

Don’t add fresh debt to your home

The first, best way to reduce the debt load on your home is by not incurring any new debt!

Until 2007 it had become common practice for home owners to take on second mortgages and home equity lines of credit (HELOCs). The prevailing theory was that rolling various high interest debts into a single, low interest loan secured by the home made greater financial sense than paying several piecemeal.

Such consolidations typically improved cash flow immediately since the single payment was usually lower than the combination of the various loan payments. This was especially true if the interest paid on the second or HELOC was also tax deductible.

But there are two significant problems with this approach:

1. It converts short- and medium-term debt into long-term debt; long-term debt has a way of becoming perpetual debt, or put another way, debt that never gets paid off, and
2. Debt that is either secured by other assets (cars, boats, furniture, etc) or is completely unsecured is now attached to the home; the more debt on the home, the greater the risk in owning it.

What few people realize about debt consolidation loans is that they don’t improve your overall financial condition. You owe as much money after doing a consolidation as you did before. Even the lower payment, while a relief to your budget, is accomplished primarily by lengthening the term of payback. You’re debts don’t go away, they just become more tolerable!

Avoid seconds and HELOCs secured by your home. Whether they’re taken for debt consolidation, to finance a major purchase or even to make improvements in the home itself, any fresh debt added to your home will put you at greater risk.

Be careful when refinancing

A second popular way people increase debt to their homes is by refinancing. While the refinance my result in a lower interest rate and monthly payment, it often does so by increasing the loan balance