Author Topic: Why do some posters say that paying off a mortgage is "risky?"  (Read 5778 times)

stlbrah

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Why do some posters say that paying off a mortgage is "risky?"
« on: December 13, 2016, 02:44:49 PM »
If anything, I would think it is too conservative.

The only thing I can think of is if someone is worried about the neighborhood declining and not having the opportunity to say "screw it" and let the bank foreclose.

brute

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #1 on: December 13, 2016, 02:47:10 PM »
In general, you can earn more in the market than you can save in interest by reducing your mortgage. Though that doesn't seem overly risky. I believe the real risk is throwing all your money at the debt without having anything in reserve. If you have $500k hanging out in non-retirement investments, there's not much to worry about. If you only have $1000 to your name, you want to build up some reserves first.

VoteCthulu

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #2 on: December 13, 2016, 03:57:24 PM »
Liquidity gives you flexibility and options. Having $100k invested in a taxable account (while owing same amount in mortgage) can give you extra emergency funds available tomorrow (depending on your broker), while accessing home equity can be harder, especially if the hardship includes losing your job.

Long term, you get better returns in the stock market as well, but all other things being equal I'd rather have the peace of mind of having no debt than earn a few percent more through leverage, but YMMV.

Lastly, if the difference is between paying off a low interest mortgage early vs. funding your tax advantaged retirement accounts like a 401k, there's no question that it's far better to get the most out of your tax advantaged options first.

waltworks

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #3 on: December 13, 2016, 05:27:27 PM »
Because your house is illiquid and about the least diversified (not to mention financially crappy) "investment" you can make. Your house can be destroyed by acts of god not covered by insurance (ie flood, tornado, earthquake, terrorism) or can lose most/all of it's value (big company leaves town, pollution makes surrounding area unattractive, etc, etc).

It's one SUPER valuable item in ONE place vulnerable to all kinds of things. That is the very definition of a risky asset.

Now, you need a place to live, and buying a house is often the best way to do that (though not always). But the idea that a house is an investment is garbage - historically housing appreciates about even with inflation.

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Tjat

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #4 on: December 13, 2016, 05:52:27 PM »
Let's replace the word house with widget. Would you sink say...80% of your assets in a single widget? How about one that is illiquid, susceptible to major damage, costs more money to maintain and the value can fluctuate by nearby widgets?

Of course not.

Just because a house is a widget you happen to live in doesn't make it less risky.

neo von retorch

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #5 on: December 13, 2016, 06:15:32 PM »
I think the easiest way to explain it is that if you don't have a sufficient emergency fund, you lose your job, and you still have a mortgage... you can lose your house! So taking money away from liquid/invested funds in order to pay off the mortgage is risky (until you exceed the mortgage and can pay it off instantly, but you still need funds to pay taxes and insurance in case of job loss.)

ender

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #6 on: December 13, 2016, 06:23:02 PM »
It depends.

Is your perspective having the money as mortgage principle OR invested? Or is it having mortgage principle AND invested?

I think most of the time this conversation comes up it is a "I have $1MM and a paid off mortgage" vs "I have $1MM and a mortgage" type of comparison.

I think the easiest way to explain it is that if you don't have a sufficient emergency fund, you lose your job, and you still have a mortgage... you can lose your house! So taking money away from liquid/invested funds in order to pay off the mortgage is risky (until you exceed the mortgage and can pay it off instantly, but you still need funds to pay taxes and insurance in case of job loss.)

Alternatively, because you have $50k of extra paydown in principle against your mortgage that is fairly locked you don't have $50k in taxable investments (or Roth principle) that you can use to avoid losing the house.

Paying off a house is great, but most of the lower risk only happens if you either use that to refinance to a lower monthly mortgage or have no mortgage entirely.


mr_orange

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #7 on: December 13, 2016, 06:50:09 PM »
Prepaying an ARM buys you a smaller payment.  I'm not sure how that can be considered risky.  With a tight fully indexed rate ARMs are often better deals for many people; especially if you have the ability to pay them off in entirety quickly. 

In general I think using cash to prepay mortgages is suboptimal.  Conflating this with it being riskier is a bit of a stretch to me.  Your primary residence isn't an investment, but the question does not state anything about this being an initial condition. 

Risk is a pretty complicated discussion that is hard to have in isolation. 
« Last Edit: December 13, 2016, 07:19:30 PM by mr_orange »

Telecaster

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #8 on: December 13, 2016, 07:00:08 PM »
If anything, I would think it is too conservative.

The only thing I can think of is if someone is worried about the neighborhood declining and not having the opportunity to say "screw it" and let the bank foreclose.

I can think of quite a few more.  Paying off the mortgage is extremely risky for a number of reasons:

1.  Paying off a mortgage only provides "safety" when the mortgage is fully paid.  Prior to that time, a job loss, illness, divorce, or other financial crisis that interrupts the ability to make the payments could result in foreclosure--even if you have made substantial extra payments.    The bank does not care, at all, about extra payments.  They only care that you make the current payment.  If the bank forecloses you are likely to lose all or most of your extra payments.    On the flip side, if you were to simply contribute the same   money to an investment account and if the same job loss, illness, divorce, or other financial crisis occurs, you could likely continue to pay the mortgage for years.   One scenario (paying down the mortgage) results in losing your house.  The other doesn't.  Which is more risky? 

2.  The equity in your house is illiquid and expensive to access.   Again, in the event of a job loss, illness, divorce, or even retirement the money is hard to get at if you need it or want it.  Good luck refinancing your loan if you are unemployed. 

3.  Opportunity cost.  This has been hashed about a lot, but bottom line is that over the life of a typical 30-year mortgage, at today's interest rates, other investments are likely to give much higher returns.   You know, liquid investments that tend to appreciate, unlike your house.   Or maybe you want to start a business.  Or just retire.  The bank, not you, determines if you can access your money.   Often these opportunities are hard to quantify, but you are taking real risks that you will miss them.   

4.  Inflation risk.  Although inflation has been tame for a while, it is a real thing.  Just say, 15 years ago, 30-year Treasuries were paying 5-6%.   25 years ago they were paying close to 10%.   That sounds like ancient history, but again most mortgages are 30 years.   Will inflation come back?  I don't know when, but it will eventually.   If it does, people who have 3.5% mortgages will look like Einstein.   Just ask the guy who got an 8% mortgage 25 year ago. 

4b.  Inflation risk, part II.   Ask your parents, or some person old enough to have paid off their house,  how much their first mortgage payment was.   Chances are they will chortle and say something like "$400 a month!"   Now of course, it isn't much money.  But 30 years ago it was a lot.  What happened was inflation eroded away that big payment and made it a small one.   By paying down the mortgage, you do the opposite!   You pay big money now in order to save a little money in the future.   How does that make a lick of sense? 

5.  Misunderstanding the result.  A lot of people think paying down the mortgage gives them a guaranteed rate of return.  It does no such thing.  Don't believe me?  Let me illustrate.  Open a 29% interest credit card.  Spend like crazy.  Pay it off every month.   You are now getting a 29% guaranteed rate of return!  That pretty much makes you the greatest investor of all time.  In just a few short years of guaranteed 29% returns you will be richer than Bill Gates.    Obviously, that's a dumb thing to say.  Unless people are talking about mortgages, then the dumbness isn't so obvious for some reason.   All you are really doing is avoiding a future expense.  Don't get me wrong, avoiding future expenses is a fine thing to do.  But it isn't the same thing as investing, by a long shot.   And if you don't understand that, what else are you missing?   

I've got a few more reasons, but that should be enough to get the point for now.   

Preemptive Statement:  At this point, someone usually points out that there are strategies for mitigating many of these risks.  For example, open a HELOC before you need it and tap the equity that way, have sufficient liquid reserves before paying down the mortgage, etc.  That's all true, these strategies do help mitigate the risks.   But they don't explain why you should take the risk in the first place. 







ender

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #9 on: December 13, 2016, 07:05:40 PM »
5.  Misunderstanding the result.  A lot of people think paying down the mortgage gives them a guaranteed rate of return.  It does no such thing.  Don't believe me?  Let me illustrate.  Open a 29% interest credit card.  Spend like crazy.  Pay it off every month.   You are now getting a 29% guaranteed rate of return!  That pretty much makes you the greatest investor of all time.  In just a few short years of guaranteed 29% returns you will be richer than Bill Gates.    Obviously, that's a dumb thing to say.  Unless people are talking about mortgages, then the dumbness isn't so obvious for some reason.   All you are really doing is avoiding a future expense.  Don't get me wrong, avoiding future expenses is a fine thing to do.  But it isn't the same thing as investing, by a long shot.   And if you don't understand that, what else are you missing?   

I think there is a legitimate perspective to seeing your mortgage principle as similar to a bond portion of your portfolio.

Additionally, if you pay down your mortgage you actually are locking in an effective return over the time period you hold the remainder of the mortgage on the additional money you pay. You are semantically correct that it's not a "gain" but it is practically speaking equivalent (assuming you correctly include your effective mortgage interest rate post itemized deductions, if applicable).

hdatontodo

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #10 on: December 13, 2016, 07:14:57 PM »
I knew the contract an external company has with my employer (which pays for me) would expire this year, so in 2014/2015 I worked to pay off the house. Then, if I lost my job, my monthly expenses would be much lower. Plus my wife had a decent income.

The only hitch in this plan was my Mrs filing for divorce and asking for exclusive use of the house for 3 years. At least, she can't argue she has an insurmountable mortgage payment and needs my assistance. Plus, since that money isn't sitting in the bank, it is not there for the splitting.

This is an unfolding situation, but I think I'm better off not having to help with a mortgage payment at the same time I'm handing over 1/2 a big bank balance.

waltworks

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #11 on: December 13, 2016, 07:20:26 PM »
Um, your situation sucks but divorce generally = 50/50. It doesn't matter if the house is paid off or not. You're not somehow getting an awesome deal on divorce by paying off early.

You can make a LOT of monthly mortgage payments with a few years of extra payments, too, so the "I know I'm going to lose my job" thing is sort of irrelevant. The really rational thing to do in that situation would probably be to sell the house and rent, not pay it off as fast as possible.

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Radagast

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #12 on: December 13, 2016, 11:53:01 PM »
If you are about to retire and live largely on your investments I think it is less risky to pay your entire mortgage if you think its inflation adjusted interest rate will be similar to or larger than your expected withdrawal rate. As others say when you are still accumulating money it is probably riskier to pay off the mortgage unless the rate is above expected investment returns, and especially if you will use all your cash and still not pay it off completely.

As for whether owning a house is riskier, it's hard to say but I always argue for risk diversification. Sure owning a house gives you a concentrated risk for declining property values or natural disasters or whatever. But these risks are very distinct from the risks of stocks and bonds and thus should lower your overall risk, provided the house is not more than 20% of your net worth. Especially if it is a well insulated house with the ability to have a large vegetable garden. Also, in a world of ephemeral electronic assets it seems less risky to have some protons around.

libertarian4321

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #13 on: December 14, 2016, 04:36:31 AM »
This ain't that hard, folks.

NO, you should not "pay off your mortgage" if it will leave you with nothing left but 3 Twinkies in the pantry and the change under the cushions in your couch.

But if you have a sufficient emergency fund, there is little "risk."

Of course, if you have far more money than needed to pay off the mortgage, then it certainly is not "risky" to do so.


matchewed

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #14 on: December 14, 2016, 05:28:44 AM »
Because even conservative things have risk. Being conservative or aggressive just shifts the risk to different things.

talltexan

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #15 on: December 14, 2016, 07:32:39 AM »
Remember that mortgage =\= house.

It's possible to take out a very reasonable mortgage on a house that is too expensive relative to your lifetime earnings. Even if the debt can be obtained at a low rate, you may still be able to live a fulfilling life with a smaller, less expensive house.

tonysemail

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #16 on: December 14, 2016, 10:33:59 AM »
inflation risk is the main way I read this too.

for some people, paying off the mortgage reduces their cfiresim success ratio. 
Isn't that sufficient to conclude it can be risky?

stlbrah

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #17 on: December 14, 2016, 11:44:01 AM »
Because your house is illiquid and about the least diversified (not to mention financially crappy) "investment" you can make. Your house can be destroyed by acts of god not covered by insurance (ie flood, tornado, earthquake, terrorism) or can lose most/all of it's value (big company leaves town, pollution makes surrounding area unattractive, etc, etc).

This is mainly the part that I don't understand. Say that company does leave town, then what do you propose, abandoning the house and eventually foreclosure?


Thanks for all of the replies. Great discussion. I agree that investing the money is a better option, but I still don't see it as a risk. I see it as more of being risk adverse.


As for me, I am paying of my mortgage relatively accelerated, but once it gets below the 80% range, I will have it appraised (hopefully only a few hundred dollars), get rid of the PMI payments, and then go back to paying the minimum.
« Last Edit: December 14, 2016, 11:46:05 AM by stlbrah »

neo von retorch

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #18 on: December 14, 2016, 11:52:20 AM »
As for me, I am paying of my mortgage relatively accelerated, but once it gets below the 80% range, I will have it appraised (hopefully only a few hundred dollars), get rid of the PMI payments, and then go back to paying the minimum.

This is almost what I did - paid it down to 78% at which point PMI is removed automatically (rather than pay for the appraisal at 80%).

Again, I don't think it's a "blanket" risk - i.e. in all situations, it is "risky" to pay down your mortgage.

But there are two clearly defined "risks" above:
 1) If your effective mortgage interest is less than your effective investment gain, you increase your risk of portfolio failure.
 2) If your income fails, and you have insufficient buffer because you used that money to pay down your mortgage, but still need to make the payments, you've risked losing your home. (So if you balance an emergency fund with accelerated payoff, no big deal.)

Midwest

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #19 on: December 14, 2016, 01:05:37 PM »


5.  Misunderstanding the result.  A lot of people think paying down the mortgage gives them a guaranteed rate of return.  It does no such thing.  Don't believe me?  Let me illustrate.  Open a 29% interest credit card.  Spend like crazy.  Pay it off every month.   You are now getting a 29% guaranteed rate of return!  That pretty much makes you the greatest investor of all time.  In just a few short years of guaranteed 29% returns you will be richer than Bill Gates.    Obviously, that's a dumb thing to say.  Unless people are talking about mortgages, then the dumbness isn't so obvious for some reason.   All you are really doing is avoiding a future expense.  Don't get me wrong, avoiding future expenses is a fine thing to do.  But it isn't the same thing as investing, by a long shot.   And if you don't understand that, what else are you missing?   


You would be the greatest investor if you could return 29% year after year.  Conversely, you would be a horrible investor if you borrowed at a guaranteed 29%  for the potential to make 30% (a yield spread of 1% at most). 

Would you argue for investing in the stock market while having credit card debt at 29%?  Unless your answer is yes, you realize the important part of the argument is yield spread.  With a mortgage costing only slightly less than bond yields, it may make sense to pay off the mortgage rather than investing in bonds in some scenarios.

stlbrah

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #20 on: December 14, 2016, 01:11:13 PM »
As for me, I am paying of my mortgage relatively accelerated, but once it gets below the 80% range, I will have it appraised (hopefully only a few hundred dollars), get rid of the PMI payments, and then go back to paying the minimum.

This is almost what I did - paid it down to 78% at which point PMI is removed automatically (rather than pay for the appraisal at 80%).

Again, I don't think it's a "blanket" risk - i.e. in all situations, it is "risky" to pay down your mortgage.

But there are two clearly defined "risks" above:
 1) If your effective mortgage interest is less than your effective investment gain, you increase your risk of portfolio failure.
 2) If your income fails, and you have insufficient buffer because you used that money to pay down your mortgage, but still need to make the payments, you've risked losing your home. (So if you balance an emergency fund with accelerated payoff, no big deal.)


With the 78%, my lender said that it would have to be the date that you were scheduled to be at 78%, so if you make prepayments/baloon payments it would require an appraisal. Was it different for you?

mr_orange

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #21 on: December 14, 2016, 01:18:15 PM »
With the 78%, my lender said that it would have to be the date that you were scheduled to be at 78%, so if you make prepayments/baloon payments it would require an appraisal. Was it different for you?

The Mortgage Professor says 5 years for FHA loans:

http://www.mtgprofessor.com/a%20-%20pmi/how_do_i_cancel_fha_mtg_ins.htm

Here is an article with rules for conventional financing:

http://www.mtgprofessor.com/a%20-%20pmi/how_do_i_cancel_pmi_(ii).htm

There is a way to issue a "fully qualified request" or some such.  If you read through The Mortgage Professor's articles there are some that show how to do this. 

neo von retorch

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #22 on: December 14, 2016, 01:28:01 PM »
With the 78%, my lender said that it would have to be the date that you were scheduled to be at 78%, so if you make prepayments/baloon payments it would require an appraisal. Was it different for you?

Yes - my credit union automatically drops PMI charges when the balance hits 78%. I'm sure not all mortgage lenders are the same, but my credit union is very consumer friendly.

ysette9

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #23 on: December 14, 2016, 02:34:26 PM »
Our plan right now is to carry a mortgage long into FIRE because per cFIREsim calculations, it would cost an extra year or two of work to pay cash and not carry the mortgage. Yes, there is the increased risk of having higher monthly costs for the first X years, but I trust the simulations. Now it just comes down to individual comfort level and what it takes to sleep well at night.

tyort1

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #24 on: December 14, 2016, 02:41:48 PM »
Based on threads like this, I'm considering re-financing our place to get a lower rate, 3.6 vs 4.0 and getting the payments lower, then taking the extra $$ every month and saving it.

stlbrah

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #25 on: December 14, 2016, 04:30:06 PM »
With the 78%, my lender said that it would have to be the date that you were scheduled to be at 78%, so if you make prepayments/baloon payments it would require an appraisal. Was it different for you?

Yes - my credit union automatically drops PMI charges when the balance hits 78%. I'm sure not all mortgage lenders are the same, but my credit union is very consumer friendly.

I did some googling and also saw the 5 year rule on the FHA. I refinanced which restarted the clock I suppose, and then started making extra payments,  so I will hit 78% around the 3rd-4th year. Might have to explore other options if isn't going to drop off automatically. My house is not very expensive, so we are not talking about big bucks here. I will probably just email my loan officer and see what my options are. Glad you mentioned it, thanks!

mr_orange

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #26 on: December 14, 2016, 04:39:23 PM »
All you have to do is read the article I linked above.  There is a process on The Mortgage Professor's site for formally requesting the MI to be removed. 

stlbrah

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #27 on: December 15, 2016, 06:41:52 PM »
All you have to do is read the article I linked above.  There is a process on The Mortgage Professor's site for formally requesting the MI to be removed.

ya, i guess im kinda screwed. i refinanecd to a new fha in 2014

aspiringnomad

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #28 on: December 15, 2016, 10:26:00 PM »
Because your house is illiquid and about the least diversified (not to mention financially crappy) "investment" you can make. Your house can be destroyed by acts of god not covered by insurance (ie flood, tornado, earthquake, terrorism) or can lose most/all of it's value (big company leaves town, pollution makes surrounding area unattractive, etc, etc).

This is mainly the part that I don't understand. Say that company does leave town, then what do you propose, abandoning the house and eventually foreclosure?


Thanks for all of the replies. Great discussion. I agree that investing the money is a better option, but I still don't see it as a risk. I see it as more of being risk adverse.


As for me, I am paying of my mortgage relatively accelerated, but once it gets below the 80% range, I will have it appraised (hopefully only a few hundred dollars), get rid of the PMI payments, and then go back to paying the minimum.

To my eyes, undiversifed and illiquid home ownership is far riskier than owning a basket of the largest 2,500 (or whatever) value-producing companies in the US. I feel like that almost goes without saying, but based on the 50/50 split of replies to this and similar threads apparently it needs to be said again and again. But with that said again and again, I realize that home ownership is appropriate for many people at some point in their lives (myself included), particularly if the numbers work out or if you're just genetically predisposed to tearing down a wall.

And if you do own your home, it's almost always sensible to do what you can to avoid paying for the bank's insurance against your own default (whotf came up with that, anyway?), which is what PMI is. So do what ya gotta do to not pay PMI at all, or at least minimize the number of PMI payments to the bank. But aside from PMI, throwing your funds into a diversified index portfolio is more sensible and less risky than throwing them towards paying down a mortgage at 3%.

talltexan

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #29 on: December 16, 2016, 08:33:45 AM »
No matter what other terms, having a high LTV ratio is the most significant predictor of default. Banks ask the borrower to pay to insure them against that default (revenue neutral to them for the loan amount above 80% of principal) when I suppose they could simply refuse to lend to that customer (but miss out on the positive revenue for that loan amount up to 80% of value).

Ben Hogan

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Re: Why do some posters say that paying off a mortgage is "risky?"
« Reply #30 on: December 20, 2016, 05:13:43 PM »
So the best compromise is the cheapest house you can with stand to live in. So the least risk and no rent?