Before paying down your mortgage balance with extra principal payments, be sure to plan carefully. The biggest risk in lending for banks is that you will suddenly stop paying your mortgage. In that event, the banks hope that you owe them as little as possible against the value of the home.
That way, your mortgage balance is covered in full and paid off in a discounted sale via foreclosure.
The fear of foreclosure is why lenders are eager to take your dollars and to help you increase your equity position through bi-weekly payments and other systems.
When banks encourage you to pay down your principal balance, their hope is that you will voluntarily decrease their risk in lending to you.
Important to remember, though: your interest rate is determined by the risk that you represent to the bank. When you pay down your mortgage balance with extra principal payments, your risk to the bank decreases.
However, do you think that the bank will call you to offer you better interest rates now that your risk is lower?
Therefore, before paying extra principal dollars, consider some of your alternatives first:
- Save for college
- Establish an emergency fund
- Fund a retirement plan
- Invest in stocks or bonds
- Pay down credit card debt
- Pay down installment loans
There are many more options, of course, but just remember that you have choices. Once you give the money to the bank on your first lien, you can't get it back without a refinance.
