Upside down? Prepare now to keep your mortgage current

Plonkee Money is going upside-down a little bit on her mortgage, and is getting a little worried.  She can afford the payments, but she’s concerned that if she were to be laid off she might lose everything.

This is a valid concern, and she’s wise to consider how to allocate her resources to protect herself against losing her house.  Being upside-down (owing more on a house than it would sell for) is not a problem by itself, as long as the payments can be made.  Being upside-down becomes a problem is when the borrower wants to refinance, or if the borrower runs into financial trouble and goes into default on the mortgage.

So, assuming there’s no immediate worry, what are some choices for preparing for this situation?

  • Pay down the mortgage. This means paying extra principal each month.  The mortgage balance goes down more quickly, and fewer payments need to be made over the course of the loan.  The minimum payment doesn’t change (in her case, GBP 500 per month).
  • Make some prepayments. This would mean paying, for example, GPB 1500 for February, March, and April, while continuing her GPB 500 per month payments.  This way, she could stop paying her mortgage for three months and still be current.
  • Invest more or save more. This is setting aside a “job loss emergency fund” that can be drawn down to cover mortgage payments and other current expenses.

So, which would be appropriate?  If the concern is not being able to make mortgage payments within, say, the next few years, then paying down the mortgage (first option) probably would not alleviate these concerns.  It depletes her reserves, but does not bring relief from making payments.

The other two options will allow her to have a cushion if her income drops.  If she’s more concerned about dipping into the reserves prematurely, then it may be wiser to make a few prepayments.  If she can leave the money alone, saving cash is better, because she can earn interest on the money.

(Note:  Thanks to Taking Charge for including this post in the Carnival of Personal Finance!)

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