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Posted 07/16/2007

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Paying Down Your Mortgage Does Not Automatically Increase Your Net Worth

Mathematics is highly-relevant to financial planning.  It helps us grasp concepts such as compounding interest, amortization schedules and return on investment.

But, forget all of the complex equations.  Basic math is all you need to get to the key point:

(Net worth) = (Total value of assets) - (Total value of debts)

There are two ways to increase your net worth -- you can increase your assets, or you can decrease your debts.  Either way works.

Most people think that paying down a mortgage increases their net worth.  But that's wrong.  Every dollar used to pay down mortgage debt was really just a dollar that previously existed as an asset.

In other words, paying $1,000 to your mortgage means subtracting $1,000 from both sides of the equation above -- a net gain of zero.

To take it a step further, the $1,000 was an asset that earned interest in your bank account.  After using it to pay down debt, it's no longer earning that interest.  Long-term, therefore, you forfeit the gains of compounded interest.

Additionally, by reducing free cash, you lose access to "emergency funds".

Should you ever need that money down the road, you'll have to apply for a remortgage with the bank to get access to it.  That process can take 2-3 weeks, and the bank may decide to turn you down.

Paying down your mortgage reduces your debt, but it isn't a safe course of action for most people.

Now, to be fair, there are plenty of instances when paying your mortgage balance down does makes sense.  For example, your mortgage interest rate greatly exceeds your savings rate and you are fully-funding your matching 401(k) plan and have a qualified insurance plan in place.  There are others, too. 

My point is that there are plenty of situations when it doesn't make sense to pay down your balance -- you just have to be tuned into to your own life goals to understand what those situations are.

There are no blanket truths when it comes to personal financial planning.  Carefully consider all of your options and make sure to talk with a professional first.

The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.

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