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Comparing mortgage pay down strategies
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Question:Should I keep a mortgage and use money to invest or should I pay off aggressively? Someone told me 'not to use your home's equity to invest'.
Answer:I can easily agree on that. Do not extract equity to invest. But I also would like to make a point that debt secured by a house is better than other debt and if you pour all your money into paying off the mortgage, you may end up in trouble. It is great that you refer to grandparents who survived the depression. Example story:
2 brothers Mike and Bill, each buy a house for 100k, both have same income. Mike makes a 15 yr mortgage and pays additional principal. Bill has an interest only mortgage and pays some principal every month, as if it was a 30yr term. He makes it in fact a 30-yr mortgage. (Yes, I know that this requires character to actually pay the principal.)
After 10 years, both lose their job. The houses are now worth 150k. Mike's loan balance is $40k.
Bill's loan balance is $85k - he did not pay down as much, but he has $50k in CD accounts.
Their net worth is very similar. Mike has 110k equity. Bill has 65k equity plus 50k in CDs = 115k.
But now they lost their jobs.
1) Mike has reserves for 6 months maybe. Bill has reserves for several years ($50k)
2) Being unemployed, Mike cannot refi his 15yr loan into a 30yr loan easily. He still has to make the bigger payment.
3) Which house do you think the bank is more eager to foreclose on. The one with 110k equity or the one with 65k equity?
My example assumes that the CD yields approximately the same rate as the mortgage. That's not unrealistic at all. In fact, if you get a low interest loan chances are that your CD account yields a higher rate than the loan.