And those two things can sound the same — why would I want more liquidity when I’m supposed to be using my liquid cash to pay down my debt? But they can become different very quickly when the unexpected happens.
I heard the following thought experiment posed to me about a month ago, on the topic of paying extra principle on a mortgage: What will you do if you pay ahead aggressively and have $10,000, $20,000, even $50,000 extra paid in, and then you lose your job? What if you’ve been so aggressive that when you lose your job, eventually you can’t make the regular payments anymore, and you go into foreclosure? Will the bank sell your house at a price that really reflects the equity you had? It’s very dangerous, this line of thinking argued, to pay too much ahead on a debt until the point that you can fully zero it out.
I find that to be pretty extreme-sounding situation, but the point was well taken. Currently, I have a contracted agreement with each of my lenders about what we’re both going to do. If I decide to give them extra cash, that doesn’t mean they’ve agreed to not ask me for more every month.