Paying off your mortgage early isn’t as hopeless as it seems
Image courtesy Stuart Miles via FreeDigitalPhotos.net
Let’s face it: 30 years is a long, long time. As Americans, we have almost come to view our mortgage as a never-ending bill, occasionally it goes up, sometimes you can get it to go down, but always, always there.
I know people who bought property for $5,000 in the 1970s and today owe $200,000! How does this happen?
It’s important to realize this “death contract”, as the word means in France, hasn’t been around all that long in its current form. In the United States, it was only in the 1930s that mortgages became the way houses were purchased. Now this had two results: It brought more homes within reach to more people and it drove up housing prices. (In much the same way car prices shot upwards once car loan became popular.) This also meant that banks had a reliable stream of income (secured by the property, of course!), which also meant that they had an incentive to keep you in debt to them. Thus, your old pals the HELOC and the cash-out refinance.
And, we know the rest of that piece of history, where the brain-dead American consumer racked themselves up a pile of credit card debt and when that bucket got too full, they used their home as an ATM and started again at zero (not counting the new additional real estate debt).
Now, because you’re a clever person and you want to pretire, you’re not going to play those games*. You’ll want to get rid of your mortgage** as soon as possible to lighten your overhead and bring you that much closer to pretirement. I am not going to waste your time with the common, tiny gimmicks like making an extra payment to principle each year. And you already know you can sell or default, so I’m not getting into that, either. You have the rest of the internet to read if you want to pick around the edges or take a shortcut. I’m talking about obliterating your mortgage, faster than you ever thought possible. It’s not easy, but it is doable in many cases.
A couple notes. There may be more than one approach that will work well. Also note that the amount you owe, your interest rate, your income and other factors may limit your ability to try these ideas. I share what I know hoping at least a few folks may be able to speed up their timeline and get their freedom back.
In effect, what we’re going to do is refi to a short-term loan, save like a crazy person and then when enough time has gone, simply pay off that sucker. To make it a little more tangible, I’ll use an example: John and Jane Johnson recently purchased their house for $300,000 and put 20% down. They have a 4% interest rate. They owe $240,000. Their P&I is $1,146. Tax and insurance is an extra $300/month so their payment is $1,446. We’ll say both make $50,000/year so jointly they bring home something like $70,000 after taxes ($5,800/month or so in take-home).
They’re depressed: 30 YEARS!! That seems like forever!
But they take a look at some ideas and decide to rework their lives. What if they…
- Refinanced into a 10-year loan at 3%
- Cut their ongoing household bills down to $2,000/month (shouldn’t be that much higher anyway)
- Cut their “fun” spending back severely to ensure they could keep up with the new payment
- And, maybe because they’re ambitious, they’re even able to scrimp and save just a bit on the side as the years go by
Let’s see what happens:
- New payment: $2,617 (including the same tax and insurance)
- Monthly bills (utilities, etc.): $2,000/month
- Fun: Next to nothing, but cooking at home and enjoying friends and family can’t be a bad thing, right?
- Loan gone in 10 YEARS!
But wait, I’m not done yet!!
So after all of that, they still have a $1,200 cushion each month for surprises or the occasional splurge. And they’ll be saving over $130,000 in interest and will be able to bank all money after the 10-year loan is paid off to put toward their pretirement fund. (Monthly income of $5,833 – $2,000 in bills – $2,617 house payment.) But let’s pull up a handy-dandy amortization calculator and see if we can get tricky!
Let’s assume our lovely couple is also able to save around $600 per month on average over the course of their loan. Now I know they’re running a little tight here at the beginning, but remember, we’re talking about many years. We can safely assume they’ll be getting a raise or bonus here or there and Jane is pretty smart and will likely change jobs a few times and end up getting that promotion. So, remember, we’re just talking about on average saving up that money over the years. (This also means not sneaking in and spending it, which is what most of us will do.)
So let’s do the math. In, say, eight years, they’ll have saved up $57,000 — enough to pay off their remaining balance! Plus, because they were smart enough to invest the money, their savings will even be a little higher! But, we’ll say their investments were quite modest so maybe they have around $60,000 at the end of those eight years — done! In fact with a slightly stronger investment or a little more saved, they could easily do it in seven years! Wow!!
We went from an endless 30-year life sentence of an expense and turned it into a trivial 7-8 year sprint.
But I have to stress a couple things:
- This isn’t easy. Maintaining strict discipline over many years is something very few people can pull off. Automated transfers and putting money somewhere where it’s a little bit hard to reach can help.
- This really only works for most people now when interest rates are this low. A much higher interest rate will make the payment too high to be workable.
But, Nick, the banks will never grant me a loan that devours that much of my monthly income. Thanks for nothing!
This is actually a legitimate concern. Banks have really tightened up their requirements and, frankly, are being quite absurd in some cases. It is possible you won’t be able to get this type of loan. (Although you should try!)
If this happens, here’s Plan B:
Keeping all other variables the same, we’ll keep the original 30-year loan. The amount that would have been going toward our 10-year payment and our side-savings, we’ll simply save on our own. So the existing payment of $1,446 will still be paid and we’ll also save around $1,200 on the side. The outgoing money is basically the exact same. In eight years, we’ll have saved $115,000 and investment growth will be at least $126,000 (really should be much more, but just being very conservative here to make the point). You can play with different timeframes and do this refi earlier or later depending on your situation. Or just keep building up your pretirement fund and eventually use that money to pay your mortgage for you. That might be a good post for another day.
Now, at this point, if interest rates are still low, you’ll do a refi (you’ll be able to get that loan, no problem) and pay down your balance. So effectively you’ll take out a new loan for $100,000. What I would do in that case is take out a 30-year loan (now with tiny payment) and simply park it and work on building up my pretirement fund.
However, if our couple really wanted to get rid of that mortgage, they could keep on saving aggressively and take out a 4-year loan instead. By continuing to save on the side at the same rate, they would be done a year early (11 years total) and be mortgage free.
Boom — powering down your mortgage in just a few years! What could be better?
*Meaning the credit card problem. A HELOC is actually a really important tool for homeowners and early retirees.
**There are legitimate reasons to retain a mortgage, particularly in a low interest rate environment. But that’s a discussion for another day.
UPDATE: If you’re considering this approach to quickly getting rid of your mortgage, be sure to check out my post on how to recast your mortgage. You can save a bundle without doing an expensive refinance.
