Pay off a mortgage or hold onto the cash?

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For family reasons in this risky market, I bought a new home in October before selling my existing home, taking out a mortgage to do so, about $ 450K on an $ 800K condo…I live in California, thus the prices. The interest rate is 5.25%.

I’m pretty sure I am FINALLY going to close escrow with a qualified buyer on my current home after falling through escrow 3 times before, usually because of bank loan rejection reasons. I own my current home (no mortgage) and was going to take the proceeds of the sale and pay off the mortgage to lower my monthly outgoing expenses and put the rest back in my investment account. I am in high tech so I was also laid off in October but was lucky to find a new job in November.

My question is, should I do the “safe thing” and take the proceeds and pay back the loan? I thought I was going to, but others have told me that (1) If I am laid off again in this economy no bank will approve giving any equity out of my house if I lose my job so keeping the money as “near cash” is a safety net to get through these hard times, and (2) With the record debt the USA has incurred, high inflation sooner or later is a near certainty and I may be able to get a higher return (possibly tax free in a muni) in a low-risk near-cash investment, while still getting a tax deduction.

  1. Reply
    charles t
    April 30, 2011 at 12:02 am

    Why not a happy medium. Pay as much of the money to a new house that you are comfortable with, thus reducing your mortgage, and putting some in cash. Better yet, how about keeping it all in cash, take the higher mortgage, and if things turn south you can still pay your mortage, and if things turn better, you can prepay more amounts towards your principal, and thus reduce your mortgage.
    You do know that you can pay more to principal above the stated amount on your mortgage contract.

  2. Reply
    doreen k
    April 30, 2011 at 12:20 am

    Since you have enough cash to pay off the mortgage in full, that would be a safe choice. An unsafe choice would be making a large principal-only payment, only partially reducing the balance of your mortgage. That is risky because you cannot always get the cash back out, and you cannot later skip the payments you have essentially pre-paid.

    However, your friends or advisers (whoever you reference as “others”) are also correct, to a point. If you are laid off, you probably cannot get approved for a home equity line of credit. BUT, you could establish a home equity line of credit while employed, and it’s doubtful that it would be closed down or frozen if you later lost your job. The lender would not necessarily even know that you had a change in circumstances.

    Also, inflation is likely in the future, but is not necessarily a near-certainty. And, a municipal bond may not be all that low-risk of an investment in the future, either.

    As for the tax deduction on paying mortgage interest – well, that is of minimal value to you. First of all, you have to pay $ 1 in interest to get back about 20 or 30 cents in reduced taxes at most. And, that equation fails to take into account the fact that it’s only the amount of itemized deductions that exceed your standard deduction that offers you any tax relief at all. Of course, if you have around $ 13,000 in itemized deductions (married filing jointly) before you add the mortgage interest, then that’s a different case, but not a likely scenario.

    My advice is to pay off the mortgage and put the rest back into your investment account. Then, apply for a home equity line of credit with a small community bank or even better, with a local credit union. Those institutions are the least likely to freeze your line of credit at any point in the future. And, continue to set aside funds for future emergencies.

  3. Reply
    April 30, 2011 at 1:11 am

    No one can predict what this economy will do in the future. We certainly hope for a more stable and positive out look in 2010 and 2011, as said at the Bill Gates-Warren Buffet conference this fall.

    What I believe is this: No one will take your house in foreclosure if it is paid off. You don’t say how much you have extra after the sale of the first home, but my strong belief is to pay off the mortgage. Secondly, with your current job in mind, fund an emergency fund of at least eight months to a year. This would include food, electricity, and car expenses.

    And here is an idea I am using. Once the smoke clears from the sale of the first house, and the pay off of the mortgage, you can get a small home equity line of credit. I DO NOT ADVOCATE using the line of credit to buy “stuff”. No, I am against any kind of credit card purchases, and further debts just for “wants”. This is only to be used if you lose you job (credit line is already in place and can not be closed then), and you have exhausted the 8-12 month emergency fund due to unemployment.

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