A common problem these days is the adjustments that ARM loans are going through causing homeowners everywhere to pay down more and more of their debt in order to level their home’s value and not be down under their ARM loan once its ready to adjust. From paying an additional $100 per month to paying as much as double their payments, homeowners everywhere think that paying down their debt earlier is the key to a successful refinance. The problem does remain that increasing your monthly obligation usually means lowering your savings account balance or choosing to not spend as you were used to.
Having had many conversations with folks regarding this bizarre trend, I offer a different perspective…
There are really two main problems you face when you choose to pay down your loan in order to save yourself from being upside down on your home.
Banks are more eager for you to default: That’s right, when you have positive equity, the bank doesn’t really have to help you in anyway. They can just choose to not help refinance you, meaning you get a nice rate hike and you can’t afford to pay your loan, which gives them your home and a profit. If you owe $800,000 on a $750,000 property, the bank will be willing and more than helpful negotiating new terms, rates and just about anything you want. This keeps you from losing your home or getting a rate and payment hike as the bank would lose a significant amount on your home. If you owe $800,000 on a $1.25 Million home, the bank is simply waiting for you to fail making your payments.
You have less freedom: The opportunity cost can sometimes be hurtful. In this economy, there is just too much insecurity to jeopardize your savings, no matter how good your situation is today. Remember that cash is king in a hurt financial climate and with credit guidelines being tougher, it is not a good idea to give up a piece of your cash in order to pay down a loan. You may not be able to move on a major purchase or simply not have enough for unexpected events.
The other perspective: Paying down your loan is not a good idea but being prepared to do so is an excellent idea. My solution is to simply open a different savings account and put the amount of extra cash you were going to pay down your loan with in there each and every month. This would allow you access to this major sum of money that you might be able to take to the table upon refinancing if needed or will act as savings in case of emergencies that may warrant a need larger than your existing savings. If your problem is solved without this money being touched, then think of it as an additional savings that you can add to your original savings account or leave aside for some really rainy days.
Hope this small tip helped.
