As post-Covid economic growth cools, the US economy teeters on the brink of recession. This daunting prospect has many looking for ways to raise their money before it dwindles. If you’re thinking about paying off your mortgage to prepare for a recession, think again.
Should You Pay Off Your Loan Before You Fail?
Greg McBride, the bank’s chief financial analyst, said most homeowners would be wise to stay the course by continuing to make monthly mortgage payments.
“In a downturn, you want to maintain liquidity, not restrict it,” McBride said. “Paying off the mortgage limits your financial ability.”
A little explanation is in order. To seriously consider paying off a six-figure mortgage balance, you need a six-figure amount of cash — “liquidity,” McBride refers to it.
So the question becomes: What if you had the cash cushion for your monthly mortgage payment and a paid-off house or a six-figure balance in the bank, but still paying off your home loan?
For most homeowners, it makes more sense to hang on to the cash and continue paying the mortgage each month.
Good debt versus bad debt
Borrowing money on a home can seem risky, but remember where loans fit in the debt hierarchy.
Some debts are clearly harmful to your personal finances. Carrying a credit card balance is one obvious example of bad debt. In this case, you’re paying double-digit interest rates years after paying for food, vacations, and electronics on the credit card. You need to pay off that debt as soon as possible, for better or for worse.
Mortgage debt, on the other hand, is the most attractive form of consumer debt. The interest rate on the loan is low compared to other types of debt, and the loan period is related to the long-term nature of the housing.
What’s more, if you’ve taken out a loan or refinanced in the past two years, you’re probably enjoying the 3 percent range. If that’s the case, there’s even less urgency to pay off the loan, McBride says. After all, you’ve locked in historically low interest rates for decades to come.
For most consumers, a home loan should be the last thing they pay, McBride says. Instead, retire any large amounts of debt you have, such as credit card balances and car loans. Then provide excess cash flow to build your emergency savings and fund tax-advantaged retirement accounts.
Think through your fears
Although the word “recession” sounds scary, it actually means that the economy is slowing down. Even a slight dip in economic activity qualifies as a failure.
It’s also important to remember: Most recessions are mild, short, and forgettable. For example, in the two decades after World War II, the booming U.S. economy experienced four recessions, but still continued to grow at an overall record pace.
In the year After rocky periods in the 1970s and 1980s — the U.S. economy experienced two recessions in each decade — recessions have become somewhat rare. The US economy entered recession in 1990, and again in 2001. While those setbacks were painful experiences for employees and investors, neither was the type of disaster that would result in paying off the mortgage or stumbling on a smart financial plan. .
The worst recession since the war 2008 is the Great Recession, and there is little chance that the 2022 recession will reach that level of a financial crisis.
Even if the economy crashes, what will you achieve by paying off the loan? If you lose your job due to downsizing, you’d be better off keeping the mortgage open and using your bank account not only to make monthly payments, but also to buy food and pay utility bills.
“Home equity doesn’t pay the bills; there’s money in the bank,” says McBride.
What’s more, if the worst happens and you lose your job, you won’t be able to touch your home equity. Lenders look for stable and steady income for a cash-out refinance or home equity loan. Without income, your home equity is locked up until you sell.
Homeowners should take heart knowing that politicians, regulators and lenders have provided generous support during the Covid fallout. Most homeowners are allowed to skip loan payments for up to 18 months without penalty. While there’s no sign of the next downturn like a coronavirus shutdown, borrowers can take comfort in knowing that another bailout from the federal government could come if things get too bad.
As with any rule of thumb, there are people in exceptional circumstances who should consider paying off their mortgage before the crisis:
One such group is made up of homeowners who are nearing retirement and the end of their mortgage terms. If you have a modest amount of debt—say, $20,000 or $25,000—and simply want to eliminate your monthly payment, writing a check for the remaining balance may make sense.
For most homeowners, however, the threat of a recession shouldn’t affect how you approach your mortgage.