10/28/2007

I usually hear two reasons for paying down a mortgage quickly.

The first is that it is a forced savings program. As I've demonstrated in the last two columns, it's not a very effective one. I'll go into more detail on that in a future column.

The second is based on fear, perhaps rooted in the Great Depression, when individuals lost their houses along with their livelihoods. The theory is that if you pay your house off quickly, you'll always have a roof over your head.

In addition, the stock market was so bad during the Depression and in subsequent years that it was perceived as a perilous place to put your money.

I'll handle this complex second set of reasons in this column.

If you take anything from this series of columns on mortgages and houses, this is it: Paying down a mortgage quickly does little to protect you from financial ruin. Indeed, early payoff puts you at far greater financial risk than diverting that early payoff money to a diverse investment portfolio.

Say you have a 15-year, $200,000 mortgage at 5.75 percent. After 10 years, you lose your job.

You can take cold comfort in the fact that you've cut your mortgage balance by more than half, to about $86,000. The bank still wants its monthly payment of $1,660.82. Because you've allocated most of your available cash to the mortgage over those 10 years, you don't have much in savings.

And because you don't have a job, you won't be able to get a home equity loan to help pay bills, including the mortgage.

But the 30-year mortgage holder (at 6.25 percent, with monthly payments of $1,231.43) has nearly $430 available to invest monthly. After 10 years, he has more than $77,000, assuming an average annual return of 6.5 percent. And because his monthly mortgage payment is smaller, he doesn't need nearly as much to hold back the bill collectors.

In times of deep financial trouble, equity in your house is almost worthless.



You don't have to fear losing your house if you regularly contribute money to a diversified portfolio of liquid assets.

Which brings me back to the Great Depression.

The investment landscape has changed considerably. Thanks to no-load index mutual funds, individuals of all socio-economic stripes can create a diversified portfolio of assets. That opportunity wasn't available in the early 20th century.

Is it possible that there will be another financial cataclysm? Sure. But the key to survival isn't paying down a mortgage; it's diversifying into all sorts of assets, from U.S. stocks to foreign stocks, commercial real estate and Treasury securities.

So your worst fear should be that your investments are insufficiently diversified.



When I've mentioned in the past that it's difficult to tap into the equity in your house, readers have suggested that you can sell it.

Perhaps.

But how quickly could you sell it? And where would you live? Jobless, you probably wouldn't qualify for another mortgage, and you might have difficulty getting a lease.

If you have a home equity line of credit open, you could tap into it. But then you're creating a double whammy: borrowing expensively and adding more debt at the worst possible time.

For additional Reading of this subject go to www.missedfortune.com by Douglas Andrew the author of "Missed Fortune 101" and "The Last Chance Millionaire"