Category Archives: Pretirement How To

How to get rid of your mortgage

Paying off your mortgage early isn’t as hopeless as it seems

How to get rid of your mortgage

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:

  1. 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.
  2. 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.

How much money will it take to pretire?

Do I really need $1.3 million?

I started this draft quite awhile ago now and since that time I tripped across this piece on early retirement math from Mr. Money Mustache (may his whiskers forever remain crumbless). MMM explains the concept better than I ever could, so please go read the whole thing.

My own story begins in my early thirties when I was having a conversation with a financial adviser. My simple question was “What do I need to do to retire by 40?” The concept that is now “pretirement” hadn’t occurred to me yet. At least not as clearly. I just knew I didn’t want to HAVE to work after that point. That was the goal I’d set and I was going to figure out a way to get there.

So I sat looking at this adviser, pen poised above my notepad, awaiting the wisdom about to come forth. The answer came back in the form of a question: “Do you have $1.3 million saved up?” This adviser spends every day dealing with folks investing hundreds of thousands of dollars, even millions. The fact I could even get a meeting was amazing. So it was pretty understandable that she looked at me with an expression that said “Why am I wasting my time on this lazy loser?” (Little did she know I was working 16-hour days at the time.)

She saw my look of dismay and hopelessness and immediately softened her response. “It really depends on how much you need to live on,” she said. “And you need to think about inflation. And health care costs. Do you think you could live on less money?”

Her math was unassailable. To have a passive income approximating a reasonable salary, say $4,000 or so, and a safe yield in the 4% range, that’s about where you end up. But that conversation in a way is where my journey toward pretirement really began. Because I realized then that I COULD live on less.

First of all, I knew I’d be mortgage-free. I was living in a smaller house and was close to being able to pay it off even then. And certainly by 40 would be easy. Secondly, I was naturally frugal and was making good income. I just needed help figuring out the plan. Much of that changed as I grew older and became accustomed to life’s finer things. That doomed me to more years of working. Then the big economic collapse happened and much of my net worth evaporated.

Nevertheless the seed was planted. Complicated spreadsheets were created slicing and dicing income and expenses many different ways. All of them told the same story: The comfortable floor for my monthly costs was somewhere between $800-$1,500, mostly depending on how cushy I wanted my life to be. Inflation was definitely an important consideration, but did I really need $4,000/month? Something seemed amiss.

Now I’m not saying I would mind having $4,000 rolling in every month. Far from it! I’m just saying working for idiots for 30 more years wasn’t worth it.

So after much reevaluation, I decided the best path was a severe cost-cutting strategy, while adding on part-time work. So the goal now is $1,200/month, or $288,000 invested. (Worth noting that I already bring in more than that passively via a rental property on paper. Unfortunately unpredictable expenses and renters have made that too shaky to rely on for income. So I’m working on restructuring that now.)

I know I’m a broken record, but I have to repeat again, that for me $1,200 per month isn’t REtirement, it’s PREtirement. I won’t be dipping into my retirement funds and I still plan to work part-time while I stay home with my son. I may even end up going back to corporate America at some point just to speed things along or to keep myself entertained. The point is the freedom, not the goal itself. If I accidentally end up working for some lunatic like I did at my last job, I’ll be free to leave and never come back. That’s freedom. That’s wealth.

I’ll likely keep working at least part-time until I at least reach the $2,000 per month income level. That’s around half a million invested. Still a long way off for me but a far cry from the $1.3 million I was told I needed all those years ago.

What do you think the right number is to reach pretirement?

My advice to the young folks

The financial advice I wish I’d been given

When deciding to start writing this blog, one of the visions I had in my head was of some teenager (perhaps one of my nephews) stumbling upon it and realizing what was possible early enough to have an amazing life, even if they didn’t come from amazing circumstances.

You see when I look back to my younger days, I now see that I didn’t have much intelligent financial guidance. I got a few great tips here and there from teachers and relatives. Some of that advice included:

  • Never carry a balance on a credit card
  • Only have one credit card at a time
  • Never use store cards
  • Always pay cash for cars
  • Only use credit for emergencies, houses and education
  • Always balance your checkbook
  • Never charge more than the amount you have in the bank at any one time
  • Don’t be tricked by sales into paying interest on a card

And so on. All great advice and for the most part I did very well by following that guidance. In fact people who don’t have basic ability to manage their finances in this manner have no business even contemplating pretirement. Unfortunately that advice, as great as it is, is as basic as being taught to read. Reading is important, but if you want to, say, be a scientist, you need to learn much, much more. There are those very special people out there who figure out the puzzle on their own, but for most of us average folks, we have to decode this mystery on our own. If we’re lucky, we’ll figure it out before we’re too old to benefit.

So here then is the advice I wish I’d been given before I was out of high school. I’ll frame this somewhat as a life-path just to make it a little more concrete. (Oh, and I definitely would recommend all the bulleted advice above.) So let’s take a look. Jjust for fun we’ll say that we’re starting out at 16 years old.

16 years old – total savings: $500 (I’m assuming you’ve saved up some birthday gift money or can at least sell of some of your accumulated crap.)
Congratulations! You can now drive a car. The thing you want most right now are wheels! Caution – Hazard Ahead! Spending money on a car could screw up your next few years. So let’s do this the right way. If your parents are nice enough to buy a car for you — take it! But if they ask you to pay for your own insurance, politely decline and save your money. If they are paying your insurance for you, great! But, guess what? You get to drive your car rarely and only to support family errands — hey they bought you  a car, the least you can do is a few errands! All that gas money gets saved!
Now if your parents didn’t buy you a car, then you have really awesome parents! It also means you won’t be tempted to show off by driving it to school and wasting tons of money on car bling and other garbage. The bus should work just fine and you’ll come out way ahead later.
Personally I’m a fan of kids who are in school working only during the summer. You shouldn’t really need the money and you should be focused on doing great in school at this point. But we’ll assume you work a summer job and make a little money here and there over the course of the year and can make a bit of money, say $2,000.

17 years old – total savings $2,500 
You have a little more experience under your belt now, so you can start doing a bit more work for extra money this year. You’re still minimizing the driving and still excelling in school. Keep saving up. We’ll say over the course of the year you’re able to save up $4,000. Do whatever it takes to make that number, except for sacrificing school performance.

18 years old – total savings $6,500 
For your last year of high school*, you’re going to need to start planning for college. We’ll assume you’re going to college because you want to give yourself the maximum options for your future. There are way too many options for me to outline all of them for you, but a couple thoughts:

  • I’m a big fan of community college. It’s a great way to beat the system and get ahead of the game
  • I’m also a big fan of taking a year off after high school before you start college. Make some money, decide what you want to do. If you want to go to a school out of state, that year can be spent establishing residency so you can score in-state tuition rates.

Meanwhile, you’ll be doing even more work, while still staying focused on schoolwork. You save up $5,000.
*Obviously the month of your birthday can determine how old you are during which year of high school. My birthday was at the beginning the school year, so I laid out this timeline to match. Adjust as needed for your own.

19 years old – total savings $11,500
You’ve passed the $10,000 savings barrier. It’s time to start investing! You can do your own homework on where to invest, but basically you should plan on trying to hit a 6% yield on your investments. Some will argue it should be a higher or lower yield. I say since you’re young you can go higher than the 3-5% safe zone, but you don’t want to be foolish either. Now that you’re out of school, a million paths lay before you. Just to keep it simple, let’s say you decide to take a year off before starting college. I don’t necessarily recommend this to everyone, but it may make sense for some. You work at least one job this year (two would be better) and you stay living at home if you’re allowed. Stay car-free if at all possible. Basically don’t spend a single dime that you don’t have to spend. We’ll say over this year you manage to save up at least $10,000.

20-23 years old – total savings $22,500
Time to go to college. Again, taking on debt for college is something I support. BUT ONLY IF NECESSARY! Do whatever you can, including going to community college first, to stay out of debt as long as possible. Since you’re going to be focused on school, though, we’re going to cut back your working hours, so you only need to save $8,000 per year while you’re in school.
Meanwhile you’re going to keep investing your saved money. By the time you’re out of school, you should have already have around $63,000 invested. At 24 years old, you’ll have assets that generate more than $260/month without you doing a thing!

24 years old – total savings $63,000
You’ve done a great job being frugal. Reward yourself with a brand, new car! Take out a loan on a new Mercedes and live it up! Ha ha, just kidding. You wouldn’t be that dumb, would you? Unless you’re lucky enough to live where a car isn’t needed, it is, however, time to spring for that vehicle. (When you think about it, by rearranging your life in certain ways, you can build a lifestyle that doesn’t need a car. Don’t be afraid to challenge what everyone else is doing.) Get something clean and reliable and keep it under $6,000. We’ll assume you were snatched up by an employer right out of college (told you that studying would pay off!) and are able to start getting serious about your savings. Start by saving just $20,000 or so off your new salary. Can you do it? It won’t be possible for everyone just getting out of school, but for many it’ll be easy. Even if you make just $40,000 per year, by being careful, you could save $18,000 per year. Keep in mind, you won’t be able to keep up with your fun-having friends. No toys, no going out, you have roommates, it may not always be super fun.

25-35 years old
I won’t outline every year now that you’re deep in your career. But let’s say you save in the coming years an increasing amount. From the 18,000/year you started with, to $20K, to $25K, to $30K, to $40k, $50K, $60K and on up to $75K and $80K. Again, your mileage may vary. With that basic schema, however, you would be able to buy a house at age 32 and make the payments with your investments or keep saving and be a millionaire by age 37. Wow!

It’s time, then, to pause and think about we managed to do. By powering your earnings into investment income, you outsmarted all the suckers. By starting early, you were able to buy your freedom from corporate America while the wage slaves are trapped under mountains of debt. By investing those funds effectively, they were able to exponentially grow to power your pretirement forward.

From then on, it’s up to you what you do. Keep working and get super rich or stay home and raise a family. Volunteer, travel, it’s up to you. But unlike most of us old guys who were distracted from this path by the lure of consumerism, you’ll be sitting pretty living the life most people only dream about.

Pretired lesson: The Power of the Chunk

boulderToday’s lesson is about The Power of the Chunk™. The Power of the Chunk is a critical concept to understand in reaching pretirement.

The funny thing about this concept is that I have found people who are strong in math (**cough**nerds**cough) have a hard time getting it, than creative and feeler types.

The principle of The Power of the Chunk was founded long ago when I left my first (very) low-paying journalism job to travel around the U.S. with a couple friends of mine. I got rid of most of my stuff and left a few things with my Dad for safekeeping. I also used his address as my forwarding address for any lingering bills and gave him some money, probably around $400, just to make sure I didn’t leave anything unpaid.

When I returned two months later, I found my money had been spent on some new electronic toys for himself. He promised to pay me back over the coming months in installments. As the money came back to me, I did what we all do — I pissed it away on nothing! 

And, thus, The Power of the Chunk was born. $100 IS worth more than $10 over 10 months!

It’s about Psychology

Now, for the nerds, this is most definitely NOT a time-value of money discussion, although at the margins there is some inter-relationship. This is about psychology.

Think about this for a moment: If I handed you $500 in cash, I guarantee you would tuck it carefully in your pocket and would likely deposit it into the bank the same day if you could. Yet how many people blow $7 on coffee in the morning and $10 at lunch, every day for years? (I am as guilty as anyone!) Do the math (OK, nerds, do your thing) and you’ll see the $10-$20 that slips through your fingers really adds up.

My favorite example has to do with the IRS withholding. You get to set the level on that endlessly confusing W4 that no one will help you with. The employee strategy on that form comes down to three possible strategies:

  • Try to nail it so you come out about even.
  • Try to come out so you definitely get money back.
  • Try to come out under so you aren’t giving the government a free loan.

The last one is the one I hear the most often and the one I think is the dumbest. The amount of money is too small (unless you’re too highly paid to need to read this blog) to generate any significant interest (either in your bank account or theirs). I always, when I was working, aimed for over-withholding so I would definitely get money back.

Why? The Power of the Chunk.

If I had this “extra” money trickled into my paycheck, it would likely just go toward buying more crap. Or a nicer way of putting it is my lifestyle would subtly rise to meet the amount of money available.

But by keeping it away from myself all year, I would usually receive a nice tax refund — my chunk. Now, of course, I realize, many (most?) of us will simply use that savings on something else, say, a big screen TV or new computer. Maybe not optimal for someone trying to reach pretirement, but, hey you saved up for a tangible item, when 90% of the population will just swipe their credit card and pay interest on top of a stupid purchase. And a few smart ones of you will actually take that chunk, which otherwise would have been pissed away on nothing, and you’ll invest it, putting yourselves that much closer to your personal finish line.

There’s another angle to The Power of the Chunk worth thinking about:  the giving end of the chunk. What if you owed a family member $1,000 (interest free) and you’re paying them $100/month until you’re even? And let’s say you did receive a nice tax refund so you could pay them back early. Should you pay off this small loan at once or should you keep paying in installments? Now setting aside the fact that you’re also robbing your family member of the Chunk’s power, I still say it’s better to pay it back early.

That’s because at Pretired.org, lowering your monthly living expenses is 90% of the game. Simplify your financial life so you can focus on the next steps in your journey.

Use your chunks to remove annoying ongoing expenses.

I paid up-front to buy my own cable internet modem. Now I don’t have to pay every month to “lease” one (that scam should be illegal in my opinion).

Or maybe you’re ready to put solar panels on your roof. It might take awhile to make back your $15,000 investment, but perhaps it makes sense for your pretirement goals to drop your monthly utility costs.

Now this concept is not necessarily going to apply to larger dollar amounts, especially when interest is involved. You may need to do some thinking about how disciplined you can be with the non-Chunked funds. Very, very disciplined people can eke out some advantages by not using the Chunk’s power and leveraging their money in interesting ways. I, however, live in the real world, where an impulse buy here or there is a lot more likely than severely tight budgeting.

Make a plan for how you want to use your Chunks before they show up. Do they all go into your investment pile? Toward mortgage principle? Down payment for a house?

The Chunks can come to you from many places so you need to ready for them when they show up. We talked already about tax refunds, that’s a common one. How about bonuses from work? From selling some of your crap on Craigslist? Maybe downsizing to a cheaper car?

You never know when the next Chunk is going to come along. It’ll pay to be ready for it.

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