I’ve already explained the differences between wise and unwise debt. Now, I want to talk more about debt — specifically home mortgages. Let’s discuss two beliefs about a home mortgage that could be detrimental to your financial health.
BELIEF 1: PAY AS MUCH AS YOU CAN TOWARD THE DOWN PAYMENT ON YOUR HOME TO REDUCE YOUR MONTHLY MORTGAGE PAYMENT.
If you are shopping for a home, I typically recommend paying no more down than the 20 percent required to avoid having to pay PMI (private mortgage insurance), which provides protection to your lender in the event you default on your mortgage. Why? Most first-time homeowners have no real idea of how much it costs just to move into and maintain a home. Have you factored in utility down payments and moving costs? Do you plan to make any upgrades, replace the flooring, paint or install new blinds or window treatments? What about the cost of furnishings? Will you need a lawnmower? If paying a higher percentage down depletes your emergency savings or requires you to use a credit card to purchase these items, then paying a higher down payment could be unwise.
BELIEF 2: PAY OFF YOUR MORTGAGE AS SOON AS POSSIBLE.
While this sounds like a good goal, it may not be wise. Very little of your payment goes toward the reduction of your principal during the first few years, so I often recommend paying an additional amount each month, depending on your situation, specifically toward principal reduction.
SOME THINGS TO CONSIDER:
Mortgage interest rates are quite low right now. Might it be wiser to put your money into a strategy that has the potential to earn more than the interest you are paying on your mortgage? Another thing to consider is whether you could continue to pay your mortgage and the cost associated with owning your home if you lost your job or had an emergency. Many people falsely believe that in the event of an emergency, they could access the equity they have built up in their home. They often don’t consider that you can’t just go to the bank and “withdraw” money from your home equity in a financial crisis. Refinancing or getting a home equity loan is a process that takes time and is virtually impossible if you are unemployed or in a dire financial condition. It all comes down to money and your ability to access it should you need to. Do you have a savings account or money you can readily access, without penalty, in the event of an emergency? Are you setting aside money for your retirement? If the answer to these two questions is no and you were to ask me about putting more money down on your new home or paying off your mortgage sooner, my answer would be don’t do it. In a financial crisis, people often make unwise choices that may seem to decrease their short-term pain but actually lead to long-term financial difficulty. Make wise choices now that put you on the road to financial well-being.