The term “forced savings account” is often used to describe a mortgage because, in essence, making regular mortgage payments forces homeowners to build equity in their property over time. This concept operates under the premise that each payment reduces the principal balance of the mortgage loan, gradually increasing the homeowner’s equity in the property. Equity represents the portion of the property that the homeowner truly owns—essentially, the current value of the home minus the remaining mortgage balance.
Here’s why a mortgage can be seen as a form of forced savings:
- Regular Payment Discipline: Unlike traditional savings where contributions are voluntary, mortgage payments are mandatory. Failure to make payments can result in foreclosure and loss of the home. This compulsory aspect ensures that homeowners consistently put money towards their mortgage, which indirectly is like saving money by building equity.
- Equity Growth: As homeowners make payments, they reduce the loan’s principal and increase their home equity, which can be considered a form of savings. Over time, as the property value potentially increases due to market conditions, the equity can grow even further, providing homeowners with a more substantial financial asset.
- Investment Potential: Real estate is often considered a stable long-term investment. By paying down a mortgage and increasing equity, homeowners are effectively investing in the real estate market. If the property’s value appreciates over time, the homeowner can realize a significant return on investment when selling the property or borrowing against the equity.
- Wealth Accumulation: For many individuals, a home is their largest asset. As the mortgage is paid down and equity increases, it contributes to the homeowner’s net worth, acting as a significant component of their overall financial portfolio.
While a mortgage does involve paying interest to the lender, which doesn’t directly contribute to the homeowner’s equity, the portion of the payments that goes towards reducing the principal balance can be likened to depositing money into a savings account. However, unlike a liquid savings account, accessing the money “saved” in home equity typically requires selling the home or taking out a loan against the equity, which can have its own costs and implications.
