When 'Overpaying'
Is a Good Thing
One Easy Way
to Shelter Yourself
from the Housing Bubble

When was the last time you heard someone say, "Thank goodness we overpaid." We've never heard anybody say that either. But, if all the hype about the housing bubble turns out to be more than hype, you might hear someone utter those words. No, we're not talking about overpaying for the house, we're talking about the mortgage — you get your monthly mortgage bill and you overpay it by $50, $100, whatever, paying down the principal.

Of course, doing so helps you own the house sooner. If you pay enough each month to add up to one "extra" mortgage payment each year, you can save yourself eight years of payments on a 30-year mortgage. But financial planning purists will tell you that that is not the best way to invest your money. For one thing, historically speaking, you probably have a low interest rate so you are saving yourself only 5-7% on that money. And in reality, it's less than that because you are probably shrinking your mortgage interest tax deduction by shrinking your principal.

So is it a good idea? Well, as you'll often hear from Debt Matters … it depends on your situation. For example, if you have credit card debt it is better to put all available money toward that rather than "extra" toward the mortgage. Or if you are saving for college for yourself or a child, you'll want to keep as much money as possible available for tuition.

Let's suppose you have paid down all your consumer debt and you are looking to start saving and investing. The first thing to do is to save up a reasonable emergency fund. After that, the people who might consider overpaying their mortgage fall into three basic categories.

People who have trouble saving
If you find yourself not getting around to saving each month, overpaying the mortgage is sometimes an easy way to put away some money that you can't touch and yields you a guaranteed "return" of whatever your interest rate is.

For the "house poor"

If you find that your mortgage payment is too much of your income, pay more toward the loan. Yes, that makes no sense. But neither does this "housing bubble," and let's face it: Many of us had to pay a lot to live where we want. If you're in this boat, the best way to correct it — short of moving to a cheaper market — is to overpay your mortgage. That way, you'll still pay a lot in principal, but you'll pay less in interest over the years. A lot less. Also, if you feel so leveraged by your payment that a lost job could jeopardize your house, then paying more to the mortgage will help shelter your most important asset.

Those with adjustable rate mortgages (ARM)

With interest rates on the rise, this is not an enviable time to have an ARM. Every dime you pay toward your principal reduces your exposure to the whims of interest rates. Also, if you have little equity in the house right now, that increases the incentive to overpay. Having little equity in an uncertain market with a rising interest rate is the perfect storm for foreclosure. The best protection is to pay down the principal and gain as much equity as you reasonably can.