User talk:Ronroge

The Road to Personal Financial Recovery and Freedom

By Ronald W. Rogé, MS, CFP® July 23, 2009

Recently we have been getting questions about paying down debt, especially mortgages.

The most common query is about paying down second mortgages (usually a home equity line of credit, or HELOC). With this type of debt the concern is usually about cash flow savings. Let's assume a client gets a large tax refund, a bonus or other unforeseen windfall. They are now able to pay off the $50,000 HELOC, saving them $600 per month in cash flow. We usually advise paying down debt of this type even if the interest rate is low and the bank eliminates the line of credit (which many banks are doing today, because the first mortgage is now more than the value of the home).

As everyone knows, Americans today are carrying far too much debt and the result is that the portion of disposable income being diverted to service financial obligations has crept up steadily to about 19% (compared to about 15% in 1980).1 So reducing or eliminating your HELOC would be a useful first step on your road to personal financial recovery.

Pre-payments on a primary mortgage are a different story. They have nothing to do with immediate cash flow savings, but they have everything to do with eliminating debt and strengthening the client’s net worth statement (balance sheet).

On a primary mortgage, if you make a pre-payment it comes off the back end of the loan. So while there’s a saving on the overall amount of interest paid during the life of the loan, your monthly payments do not change. You’ll just make fewer payments over the life of the loan.

So our recommendation to clients is to use the monthly cash flow savings from paying off that HELOC and make an extra monthly pre-payment on the primary mortgage every year. This strategy will help pay off the mortgage sooner and save on the total amount of interest paid over the life of the loan.

One thing you should definitely avoid is engaging in clever calculations that lead you to invest borrowed money in the hopes of achieving higher returns. This kind of activity is in fact engaging in what is called risk arbitrage, and it can be very hazardous to your financial health. Most Americans can’t afford to take this kind of risk because their balance sheets are not strong enough to absorb the losses should this strategy fail. And the odds are high that it will. Rather than engaging in speculation, focus instead on eliminating high-interest debt.

Today, it's all about reducing risk and paying down debt. People want to feel good about their finances and sleep better at night. We can't go on deceiving ourselves that we can rely on banks or the government to take care of us. Real financial freedom is all about being less dependent on these institutions and relying more on our own resources.

Ronroge (talk) 20:45, 9 September 2009 (UTC)Ronald W. Roge Source: (1) Federal Reserve