“It seems like we will be making house payments forever. We owe $140,000 at 6% interest and are paying $1000 a month. How much sooner could we pay off our mortgage early if we started paying an extra $100 a month?”The above is a hypothetical question, but it could be you. There are two answers: the quick one and the “dig deeper” one. By clicking a few buttons on a financial calculator we discover the quick answer is 21 months; paying an extra $100 will reduce the payoff from 20 years to 18 years and 3 months.
COULD you pay off your house early? Sure. But SHOULD you?
Let’s dig deeper. Do you have other debt? Do you have any savings? Do you have an emergency fund? Are you on target with your retirement investments? Do you have children who will need some help with college funding?
Being as this is a hypothetical case, let’s say you are paying $300 a month at 12% APR on $5,000 on credit card debt and $500 a month at 8% on an $8,000 car loan. You have $2,000 in a savings account, nothing set aside for emergencies, you are on target with retirement investments and you have two children, ages 4 and 8. Your challenges are to not only get your house paid off, but also get out of debt, build an emergency fund and make plans for your children’s education. Don’t get overwhelmed. You can accomplish all of these and still pay your house off early by setting priorities and taking things one step at a time. Let’s develop a plan.
Clearly Communicated Budget
Yes, the dreaded “B” word…you knew it was coming. But until you are in control of your money, you simply cannot develop any type of a plan. It is essential that you and your spouse communicate openly while developing this budget. Discuss hubby’s dream bass boat and your dream kitchen. Leave nothing out now because it will surface later. Let’s assume you two worked together and decided that by eating out less, simplifying your vacations, getting a smaller tax refund and cutting back on Christmas spending, you find $500 a month positive cash flow.
Small Emergency Fund
Life happens, so you need a small emergency “buffer” fund. Simply label that savings account as an emergency fund and agree not to touch it for anything except emergencies. Voila! Your small emergency fund is complete.
Get Rid of Credit Card and Car Debt
We will come to paying your house off early in a minute, but let’s first free up more cash flow by attacking your credit card debt and car debt in that order. Keep making your regular car payment while bumping up your credit card payments to $800 a month (the $300 you were already paying plus the $500 you found in your budget). In seven months, when your credit card debt is gone, add the $800 you were paying on the credit card to the $500 you are paying on your car. With new payments of $1,300 a month on a car debt (now down to $4,800), it will be gone in about four more months. Are you still with me? You have just paid off your credit card debt and car loan in only eleven months. By doing so, you have bumped your cash flow from $500 a month to $1,300 a month. Congratulations!
Time for a Big Emergency Fund
Grandma called it her “rainy day fund” for good reason: rainy days come. A big emergency is a higher priority than paying off your house early because when emergencies come, you need readily accessible funds. More equity in your house would not help if you lose your job tomorrow. Depending on your number of income streams and volatility of your job, you need at least three months of expenses; many financial planners recommend six months and some nine months. Let’s assume your expenses are $3500 a month and go for a six month emergency fund. Your goal therefore is $21,000, so you need to save $19,000 to add to the $2,000 you already have. At $1,300 a month, you will need at least 15 months to achieve this goal. After only 26 months, you have paid off $13,000 in debt and saved another $19,000. You are on fire!
Retirement
You said that your retirement was on track, so I am taking you at your word. If it wasn’t, you should be investing enough of this $1,300 cash flow each month to bring your retirement investment level up to 15% of your take home pay.
Kid’s College
Your two children are now 6 and 10. You could start making huge house payments now, but, because that added home equity cannot be easily converted to cash, college funding becomes a higher priority. For sake of discussion, you could achieve a $40,000 nest egg for each of them at age 18 if, assuming an 8% return, you start investing $300 a month for the oldest and $220 a month for the youngest. Check into a 529 plan to get some great tax breaks.
Finally! Pay the House Off Early!
You have been making $1,000 a month house payments all along, lowering your mortgage balance to about $132,000. Your monthly cash flow is now $780 a month ($1,300 a month less your college investments of $520 a month). If you decided to use all of the $780 to pay extra on your house, it would be paid off in only 7 years and 9 months – a total of 9 years and 11 months from the time you started your plan. At that time your payoff schedule was 20 years. You are awesome!
Summary
Our hypothetical family was able to pay off $13,000 in debt, save for a $21,000 emergency fund, plan for their kids’ college and pay their house off 10 years early. How did they do it? By creating a budget, sacrificing and developing a plan. I have a hunch that if you follow their lead, you would also see amazing results.
Note: I wrote this post originally for Christian PF.
photo credit: The-Lane-Team
Readers: Have you paid off your house early? What tips do you have for others considering it?
Your hypothetical family also had 2 intangible, but very important, traits going for them – vision & dedication.
Not owning a home myself, I do have a very interesting story about my parents.
They had a 15-year loan, but ended up paying it off in 5 years! During that time, my dad was also temporarily unemployed and going back to school. On top of all this, they still funded their IRAs and retirement accounts.
Their drive simply amazed me, and I didn’t become aware of this until many years later. Even though it’s one small story – it shows it can be done!
@FinEngr
I completely agree vision and dedication were certainly a factor. It’s hard to get there just with the numbers alone. Being able to see it (vision) but unable to implement it (dedication) won’t get you there either. One more thing is life happens: meaning there are some emergencies and unexpected transitions that will occur. Even if the large emergency fund covers the problem, you still have to put your “total money makeover” on hold to rebuild it. That’s one reason to do what your parents did, which is to do it really quickly (5 years). Still, this is a very solid and straight-forward plan. Good stuff!!!
@Fin Eng,
Wow. Your parents must be an inspiration to you. They demonstrate that the intangibles of vision and dedication will carry the day when life happens (unemployment, etc). I wrote the post to show the numbers of how a plan works, but the plan, as you said, needs to be complemented with vision and determination. You should write a post telling about your parents’ success in spite of adversities.
@Roshawn,
I agree that it’s hard to get there with the numbers alone. But the numbers tell us that it is possible. Hopefully, the numbers will help create some of the vision needed to go for it. The dedication comes from deep within, so if someone does not already have that dedication, I am not sure how to help him get it. I wish I knew Fin Eng’s parents…don’t you? They are an inspiration!
You make finance sound so simple ;). I love how you detailed paying off the credit card debt, car, and building an emergency fund in simple, easy steps. I have two questions for you:
1. How do you feel about paying off student loan debt as opposed to credit card debt? For instance, you have a $7,000 credit card debt at a high interest rate and a $10,000 student loan debt at a low rate. Obviously, tackling the credit card debt is a no brainer. What about paying the student loan debt off quicker? Should it be done?
2. How the heck do people have mortgages of under $2,000?! I guess living in Southern California has jaded me or made me think all rent/mortgages are in the 2K ball park. ARGH! Maybe I’ll become an urban nomad. 😉
Great post Joe! Thanks for the link too!
Hey, Joe! Thanks for the shout out!
“Until you are in control of your money, you simply cannot develop any type of a plan.”
That just about sums it up, and your post is a terrific illustration of how it can be done.
@Little House: Believe it or not, I live in SoCal and my mortgage is a hair over $600 per month! Oh yes! And I live only about a half hour from the heart of downtown LA. When I first bought the house in 1997 the mortgage was $1400 per month, but after faithfully paying down my principal over the first 10 years, and a series of four strategic refinances (none of them cash out, they were all focused exclusively on lowering the interest rate) I managed to reduce the mortgage to its current level. It can be done!
Best,
Len
Len Penzo dot Com
@Little house,
We agree that paying off credit cards before student loans is a no brainer. “But”, you are saying, “should the student loan debt be paid off quicker?” My answer: “Yes!” I am for getting rid of all debt as soon as possible, saving the mortgage for last. Doing so not only frees up your cash flow (as illustrated in the post), but also frees up your spirit. Without debt, you have a new look on life, more options and greater creativity.
About the house mortgage…Len answered that one pretty well. Or, you could move to the Midwest. 🙂
@Jason,
You’re welcome.
@Len,
Thanks for the good word and for helping with Little House’s question.
@Len – You are so smart. I really think you should start your own magazine, similar to consumer reports. You could call it Len’s Financial Reports, or something like that. Maybe once I purchase my own property, my monthly living expenses will go down. With rent, I’m sort of stuck for now. Thanks for sharing that info!
Joe, your writing style is inspiring! I don’t have a mortgage or credit card debt, but I’m still fired up about this stuff!
This shows that with careful planning and dedication, getting ahead financially doesn’t have to be extremely difficult. Think of it like a game, and it can even be fun!
@ Roshawn:
Good correlation using the terms I thew out there. Ha – total money makeover. That’s a worthwhile point to add – people talk often of an “emergency fund”, but if you use it for what it is – that can drastically alter your financial picture.
@ Joe:
Nothing spectacular – just regular folk, but thanks! Not entirely comfortable sharing detailed, personal information – maybe a general post on traditions & family values is in order. While I haven’t (yet) had to deal with many of the financial worries others have, my perspective was nonetheless shaped by their actions and its a very clear example of the benefits!
@Darren,
Thanks for the encouraging words. Sometimes simply showing the numbers can inspire people … they simply don’t know what can be accomplished by getting focused, developing a plan and sticking with it. I like your observation that personal finance doesn’t have to be difficult; that it could even be fun, like a game. Hmmm. Sounds like something you should write about. 🙂
@Fin Engr,
I hope you decide to write the general post on traditions and family values. I would love to read it. And if you ever write about your parents, let me know. I would love to meet them vicariously through your writing (or in real life too!).
@Little House: Ahhh, thank you! Now you know what I am going to do? I am going to show your nice comment to the Honeybee as proof that I am NOT as crazy as she thinks I am! 😉
Len
I would venture to say that the way the majority of people try to pay off their homes make this move a risky investment!
Imagine an investment:
– You can pay the minimum contribution but not less.
– If you attempt to pay less, the financial institution keeps all of the previous contributions.
– Money in the account is not liquid and not safe from loss of principal.
– Money deposited in the account earns zero percent rate of return.
If you have a traditional mortgage, you have this investment.
If you want to “own” your home, I think the safest way is to keep the equity separate by using products like an interest only mortgage loan. Once you have the money saved up, stroke one large check to pay it off.
Separating the equity from the home leaves the power in the consumer’s hands and not the bank. You can then put it into a liquid, safe, interest earning vehicle. Doesn’t that sound better than letting the bank use your money to earn them more money?
@Bern,
Most people use such logic when signing up for the interest-only loans. Additionally, people use these vehicles to over-leverage themselves with homes that they could not afford with traditional mortgages. In such cases, the only way their payments “fit into their budgets” is because they are not paying any of the principal. The vast majority of people don’t save, and those who do don’t save much. This is just a fact. Our savings rate is approximately 3% right now, and dare I say that most of the people with interest-only loans are not doing it so that they can save the difference. People rarely stay in the same home anyway, so with these interest-only loans, many people never pay them off, never have any savings, and don’t take any of their principal with them when they move. No thank you! Personally, I think this is very dangerous advice.
@Bern and Roshawn,
Thanks to both of you for your thoughtful comments. I will go with Roshawn on this one: run as fast as you can from an interest only loan. The risk is not worth it…what if one needs to relocate unexpectedly just when market value has hiccuped? You can’t sell your house and you are stuck with renting elsewhere (AND continuing those interest payments) until you sell it. Life happens and good personal finance means limiting risk by planning for those contingencies.
@ Roshawn,
If the problem is that people aren’t saving, then it’s an issue with homeowner and not the strategy of using an interest only mortgage. They won’t save with a traditional mortgage.
If the person were to save, it is better to keep the equity liquid, safe, and earning interest rather than in the home. Equity in the home is risky.
People want to pay off their home with amortized schedules because that’s what banks want you to do. And, they’ve done a great job fooling everyone…
Great article! Thanks also for the link to my article! Best, Rob
Wow this is a great resource.. I’m enjoying it.. good article
@physical therapist,
Thanks for reading! Don’t be a stranger.
Thanks for posting this. It articulates greatly what my family and I are attempting ourselves. Power through the low hanging fruit and then attack the bigger chunks. It’s working so far…