Sometimes a homeowner may make additional principal payments on a fixed mortgage to shorten the term of the loan, in essence, prepaying the mortgage a little at a time. By paying an extra $20, $50, or $100 each month toward that principal the debt will go away years ahead of schedule. This sounds like a great idea. But I have a better one.
Rather than paying the additional principal to your lender, make the decision to deposit it into a savings account. Follow the same discipline and schedule. Make the deposit every month as you make your regular mortgage payment. As the statements arrive on your savings account, note the balance will grow.
At the same time your principal will shrink. At some point in the future, the values will match and you can decide to pay off the mortgage at that time if you wish to.
What are the advantages of this plan? First you will be accumulating interest over the years on the savings. That interest will accrue in your account. If you give the money straight to the lender, you will lose out on that interest. It may sound trivial, however, as the savings balance increases month after month and as the years tick by, you might be surprised at how much interest you accumulate. And the bottom line is, even if the interest is $100, it is worth $100 less you have to find to payoff the lender.
The major benefit to doing this is creating the option for yourself to use the money for other purposes. When you give it to the lender you no longer have access to the money unless you apply for a home equity loan or a home equity line of credit. These loans costs additional money to create, usually. Once you borrow the equity you then have to pay it back with interest.
Having saved your own equity provides the option to borrow from yourself, interest free and with zero sign up charges. You do not need to have your credit pulled or sign a note. In the event of a financial emergency, you could use the equity account as a rainy day fund. If a large car repair comes up, or an unforeseen medical expense occurs, or suddenly you have to travel you will have access to the option of borrowing it from yourself.
Pay yourself first. It is financially shrewd and it will provide you flexibility, choices and greater peace of mind knowing you have an extra layer of financial security.
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