Lately I’m dreaming about mortgage freedom.
This may be surprising – after all, my mortgage only has less than 12 years left at 2.75%. The balance over the past three years (since it started-it’s a 15 year) has dropped almost $50k. Every month the balance goes down by over a thousand dollars, thanks to the rock bottom interest rate and the 15 year term. In 12 years I’ll be 48, which still gives me many years to a traditional retirement.
So then why do I dream about getting rid of it sooner? Two words sum up my reasoning – security and freedom.
You’ll notice that neither reason mentions that this is the financially best decision that will leave me with more money at the end. And that’s because I know that it’s not optimal. After all, with such a low interest rate environment I could likely earn more money by investing in the stock market, buying bonds, or securing investment real estate. Tying up my money in my primary residence won’t give me a return on investment – heck, my house today is worth about what it was when I bought it. I have no assumption that it’s going up anytime soon, and I’m not renting it out. Currently I don’t plan to sell it when I retire. And I’m well aware that in 12 years risk-free interest rates might go up above my current rate.
I find that you can’t put a price tag on security. Why does mortgage freedom mean security? Well the mortgage is my largest expense. I have no other debt – no credit cards, no car loans, no student loans. The only other monthly expense that comes close is my 401k contributions, to which I contribute the federal maximum. Getting rid of the mortgage reduces the risk of financial disaster in case of a job loss, death, illness, or any other life situation. Our family has been through significant job loss, illness, and total disability – so security is extremely important to us. We had many years where coming up with the next payment was a stretch, although we always managed to come up with what was needed to get to the next month. Having no mortgage payment every month would reduce my monthly expenses significantly, making a disaster more financially manageable.
Now what about the freedom part of the equation? Having no mortgage gives me more options in life. I often see people at work playing out Alice in Wonderland – running as fast as they can just to stay in the same place. In evolution this is called the Red Queen hypothesis. For my coworkers and friends, this means that they need to work as hard as they can as long as they can to pay for the lifestyle they lead or want to lead. I stepped off that treadmill long ago, but I want even more options. Not having to make my monthly mortgage payment reduces my expenses by a third. This means that I can deploy that money toward other goals instead, such as saving for college for my three boys. I could take a significant pay cut to work less or switch into another field. I could start my own business, easily setting aside enough capital to launch a small company and work for no or low pay for some time. It gives me the freedom to run my life rather than having my life run me.
Now this wasn’t a decision I made lightly. I did a ton of research online about paying off the mortgage faster, but I would find much of it not applicable to my situation. Or I would find that the articles were written by banks, which have a vested interest in having you in debt as long as possible. Or the articles were written by investment professionals who get paid more if you invest, and get paid nothing if you pay down debt. But I did manage to find a few good articles (like this one from Investment Zen, this one from DQYDJ, and my personal favorite, this in-depth analysis from the Financial Mentor)and this one from that laid out a detailed thought process behind the decision, which I really appreciated. I hate biased advice, especially when they don’t tell you why they would be biased one way or another. Side note – always investigate the source of the information you’re reading online. Consider how they get paid. Try to seek out people and advice that doesn’t come from industries that benefit if you (1) take out debt and (2) invest more. That’s why I like PF bloggers more than mainstream media at times
In order to determine if this was the right path I felt strongly that I needed to really understand and analyze the arguments against this approach. Once done, I could be more sure this was the right choice for my situation. So what were the arguments against paying off the mortgage, and how did I analyze them?
Just invest the money – you’ll earn more in the long run. It’s certainly true that investing should produce a higher long term return than paying a 2.75% loan. In fact IBonds are now paying 2.76%-more than my mortgage. So I thought about what would happen if I still had the mortgage and wanted to achieve financial freedom. In order to generate enough money to cover my mortgage payment – $1750 excluding taxes and insurance (since I still have to pay those once the mortgage is paid for) – I would need to have $525k set aside at the 4% safe withdrawal rate. But I only need $200k to pay off my mortgage, and then the other $325k could be deployed to other goals or used to generate a safe withdrawal rate of $13k each year. That would cover a significant amount of my monthly non-mortgage expenses. Also, you’re comparing apples with post-it-notes if you compare investing and debt payoff. Debt payoff is risk free and not volatile. It’s guaranteed. There is no guarantee in investing. Sure, based on historical information you’ll earn a long term average of approximately 10% if invested 100% in stocks. But every source will say that’s not guaranteed. Even those IBonds I mentioned above reset every six months, so they’re only guaranteed six months at a time. I’ve lived and invested through two stock market crashes now – the dotcom crash of 2000 and the Great Recession of 2008/2009. Although I stayed invested (so I know I won’t panic and sell at the bottom), I know how bad it can get for periods of time. I think some more recent investors don’t realize how fortunate we are that the 2008 Great Recession market came back relatively quickly. It can go sideways for years. I invested during the “lost decade” from 2000-2010, when the market returned a whopping 1.4%. Paying off my mortgage would return more than that.
Your monthly interest rate is lower after the tax deduction. This was actually one of the biggest shocks of going to a 15-year mortgage. My payment was the same, but I owed a lot more in taxes and had to adjust my withholding. This was because more of the payment went to principal rather than to interest – which is a good thing! But principal isn’t tax deductible, while interest is. The past three tax years I’ve barely had enough deductions to itemize, so my personal after-tax rate equals my before-tax rate. The standard deduction for my family is $12,600. So my mortgage interest, property taxes, etc. must exceed that dollar amount in order to get any tax benefit from the mortgage. I suspect in a only one or two more years the interest is going to cause me to not qualify for itemization at all. So this isn’t a concern for me.
You should pay off higher interest debt first. I agree with this one. If you have credit card debt, student loans, personal loans, or car loans those need to go first before you would tackle the mortgage. After getting the rates as low as possible (by refinancing with a company like SoFi, where you can get a credit by going here [link] or here [link], or checking out Magnify Money [link] which I heard about on Stacking Benjamins) you should tackle these debts before going for the mortgage. But I have no other debt, and I haven’t for three years. So this doesn’t apply.
You need to save for emergencies. Agreement here, if you don’t have money set aside for emergencies you need to build up your cushion first. Although I don’t necessarily agree with only having an emergency fund – you need to have a detailed emergency plan, like I’ll talk about in a future post. I have 12 months’ expenses in a savings account, and another 8 months in savings bonds, which is more than I need for my plan. So this is set.
You need to save for retirement first. I also agree with this. Take a few minutes to calculate what you have saved for retirement and what you’re putting aside each month, and head over to firecalc [link] to make sure you’re on track. I’ve been saving in retirement accounts since I was 16, when my father matched what I put aside into an IRA. Since I started working full time during college, I’ve put away anywhere from 10-15% every year (except when I dropped to 6% when executing my emergency plan. Currently I contribute the federal maximum of $18k per year to my 401k, plus I get an additional match from my company of $6750. So I have $25k every year invested into retirement. With my current balances plus this contribution I’m on track to way overshoot any amount I would need at traditional retirement age. So I’m good here.
You need to save for your kid’s college. I have three boys, ages 12, 9 and 1. I assume one day I will need to send them off to college, and this is a very important goal for me. Every month I put something aside in various 529 plans, and I’ve calculated exactly what I need to meet my goal. But I eventually realized that paying off the mortgage could be an aspect of the overall plan. Remember how my mortgage payment equals $21,000 per year? That alone is almost enough to fully pay for a year of tuition, room, and board at my state’s flagship university, which is my goal amount. Well what if your kids want to go to a private college, go out of state, etc.? That’s not what I’m willing to fund, and my kids will need to make up the difference. If going to a private or out of state school is important to them, then I will encourage them and help them, but they will pay the difference. How? Jobs, scholarships, grants, and loans if needed. I’ve already started talking with my eighth grader about this concept when he was interested in going to Wesleyan, a $60k per year school. If I get rid of my mortgage, then I can cover college out of what I’ve already saved plus cash flow. The sooner its gone, the sooner I can redirect that money to college.
My analysis showed that I was in the perfect position to focus on the mortgage. No debt except the mortgage. Solid emergency savings and plan. On track for retirement and college. It was time to run the numbers. Pop over to my favorite mortgage calculator to run your own scenarios [link here]. My starting balance was around $250k in July 2013, at 2.75%.
|Extra Payment Option||Payoff Date||Comments|
|$0||07/2028||If I don’t pay an extra dime, the mortgage will be gone by the time my middle son wraps up his junior year of college. I could then fund his senior year and my youngest son’s college from cash flow. Not shabby, and much better than where I would have been with a 30 year. But I can do better than this.|
|$100 a month||11/2027||Many times when reading mortgage repayment general advice, I’ve seen vague promises that adding only $100 a month will shave years off your mortgage. Well, those articles are talking about a 30-year mortgage. Adding $100 a month barely moves the needle on a 15 year. At least it would be paid more toward the start of my middle sons junior year instead of the end, so I could use cash flow for two years. But I want to be free way before this. So what will that take?|
|$5000 a year||01/2026||This plan involves setting aside money as it comes in and making a lump sum payment of $5k every year in December. This starts to move the payoff much more significantly, to more than two and a half years early. My middle son would be a freshman in college, about halfway through his first year. So I could fund nearly his entire school and my youngest son from cash flow. What would it take to move this into my oldest son’s college time? Let’s try doubling this.|
|$10000 a year||01/2024||OK now we’re somewhere in my oldest son’s college time – in the middle of his junior year, in fact. This is more aggressive but getting better in terms of timing. But I would still need enough set aside to cover the first two and a half years of college, or borrow and pay back the money out of cash flow.|
|$156,832.30 One Time||12/2019||Yeeeeesssssssssss. This one.|
I’ve found that I do best when I have a big, audacious but achievable goal. I was reading a great book about this over the weekend – I’ll write a review on that soon. Studies show that having a stretch goal paired with SMART criteria (Specific, Measurable, Achievable, Realistic, Timebound) is the best way to achieve what you want.
I started running various lump sum scenarios for fun, and when I saw the December 2019 number I knew that was the goal for me. You see, part of my hesitation with early mortgage payoff involves something that lists often don’t talk about – the fact that your money is locked up and can’t easily be taken back out. Like paying off the mortgage in the first place, this is not the financially optimal choice. After all, paying off the mortgage as you get the money coming in causes you to pay less overall in interest. But there were too many “what if’s” for my comfort. What if I needed to pull the trigger on my emergency plan again? What if interest rates start going back up (I’m old enough to remember earning 5% on a savings account) and I could earn a higher risk-free return with the money again? What if I change my mind and decide that 2028 will work fine?
All those “what if’s” can paralyze you into doing nothing. But instead I decided that I would make a plan that would knock off those “what if’s” one at a time. Saving up for a large lump sum would get rid of the interest rate increase risk, because if rates went up I could simply put the money in a CD. If I needed the money for a true emergency, I would be able to get at it without needing to take another loan or sell the house. If I changed my mind and decided that another goal was higher priority, I could redeploy the money elsewhere.
The goal amount was big enough to be a challenge, but not big enough to be absolutely impossible. Paying off the mortgage in 2019 means it will be done a year and a half before my oldest starts college. I would have a year and a half to save that mortgage payment, plus all the extras I was throwing at it, which would be more than enough to cash flow college after adding in what I’ve already saved in the 529. And I could use that year and a half of mortgage freedom to meet one of my other dream goals – taking the family on an international vacation before my oldest went off to college.
What are your thoughts on mortgage freedom? Are you the type of person that prefers investing over paying it off? Let me know in the comments.