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Should I Pay Down My Mortgage?


Q & A

Today’s Question comes from a client whom I’ve helped several times over the years.  I think he was one of my first 5 clients back when I first began in real estate.

Q: I own a home that is currently worth less than what I owe on it.  I would like to refinance, but in order to do so, I’d have to pay down my mortgage enough that the bank would consider a refinance.  Is it worth doing?

A: I have two answers to this question, and the answers depend on the type of loan, and the LTV.

Answer #1 – According to  Pete Bailey with Windermere Mortgage, if the existing loan on the home is with Fannie Mae or Freddie Mac AND the LTV (loan to value) does not exceed 125%, you may be eligible to refinance your loan without paying down the mortgage. If you’re not sure what type of loan you have, contact your current lender or give Pete a call for specific eligibility requirements. If you have an Fannie Mae or Freddie Mac loan, and the cost is negligible to refinance, then you should absolutely do it.

Answer #2 – If you can afford to make your existing payments without a great hardship, and the amount of money that would be needed to bring down the LTV is significant (i.e. payback period between the new loan and the existing loan is greater than 2 years or 3 years), I’d strongly advise against it.  Instead, I’d put the money into other investment vehicles where the return is better.  A few alternatives to paying down the mortgage would be:

  1. Emergency fund: (you should have at least 6 months of living expenses in a liquid account in case of emergencies).  If you don’t have this, then that should be your first priority.
  2. Paying down other high interest debt: If you’ve got some high interest debt (credit cards for example), you should focus on paying down that first since interest paid is NOT tax deductible.

One of the reasons I’m against paying down the mortgage quicker than necessary in this current climate is that right now, your home is a depreciating asset.  Nobody knows exactly when the housing market will hit bottom. Intentionally paying down your mortgage right now is like investing in Worldcom stock. Unless you are close to retirement AND are able to completely pay off the existing balance AND plan to stay in your home for a very long time, it’s a losing proposition.

Consider this simplified scenario:

You own a home worth $200,000, and your mortgage is $200,000. The market is declining at a rate of 5% every six months for the next year or two.  You are considering paying down the mortgage by $10,000 with an inheritance you just received.  So now, your balance owed is $190,000 on a $200,000 home (95% LTV). In this scenario, your home would be worth $190,000 in 6 months from now, so your balance and value would be the same again, with a net equity gain of ZERO!

Of course, every person’s situation is unique, and a financial adviser should be consulted prior to making such an important decision.

Q: Does your answer mean that you don’t recommend housing as an investment right now?

A: Not at all. It just means that I am a proponent of leveraging your financial assets ($$). I think right now is a great time to buy (even in a declining market as long as you plan to hold the investment for at least 5 years or more, and you are able to acquire the home with as little cash as possible, thus leveraging your money).

There are many factors to consider, and if you want more specific details, drop me a line…

Got a question? Got an opinion? Leave a comment…

When REALiTY BiTES, bite back!


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