I am often asked when a homeowner should put the focus of paying off their mortgage. Although the answer to this question is specific to each homeowner, my general recommendation lies within a 4-step plan that I use to advise each of my clients.
Each step is numbered based upon the priority. In other words, step one should be on track before moving on to step two, and so on. The problem is that many homeowners jump ahead before the prior step are mastered. This typically leads to living paycheck to paycheck, getting stuck in the consumer debt rut, or reaching retirement to find that you are equity rich and cash poor. By following the steps below, you can help ensure you reach retirement having achieved the long-term goals you desire.
Step 1 – Develop a Cash Reserve
The most important step is to have a reserve fund to cover short-term unplanned expenses. Without having cash reserve, shortages typically result in having consumer debt. Once consumer debt is established, it can lead to destructive long-term habits that are difficult to break. If you have a cash reserve, you should never have a need for unsecured debt.
Step 2 – Pay off ALL Consumer Debts
This is the step where you become consumer debt free, with the exception of your mortgage. Revolving and unsecured debts should be paid off first, with car loans and other secured loans being paid off second. Remember that cars are depreciating assets, and you will always have car expenses. If you are able to pay off your car, you can begin to save money to pay cash for your next car.
Step 3 – Create Significant Liquidity
One of the greatest gifts we have is the gift of compounding interest. This is the quadrant that grows and compounds. Even if you are not secure in steps 1 & 2, if possible, you need to develop the habit of putting cash into long-term investment accounts. Once you are secure in steps 1 & 2, make this quadrant your primary focus and watch your net worth rise over time.
Step 4 – Focus on Home Equity – Paying off your Mortgage
Once you have developed a cash reserve, have paid off all consumer debts, and are on track to meet or exceed your retirement goals, then you can put a focus on paying off your home loan.
Personal finance is most often a reflection of habits. If you develop good financial habits, and exercise them over-time, long-term you will likely do well. Not only can you use the four step plan to help you allocate cash flow in the budget, but you should also use the plan to help you to allocate cash and home equity net worth.
If you have specific questions regarding your personal situation, please call or send me an e-mail. Also, if you have a friend or family member in need of advice, I would be honored to help them as well. Having professional advisors to help you manage your investments, mortgage, taxes, and estate is the best way to protect your long-term results.