Murder Your Mortgage in 7 Years Q&A

In Mortgage Snowball by Gen Y Finance Guy29 Comments

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Last month I published a post that detailed my strategy to pay down a 30 year mortgage that I only recently obtained last year. I will be the first to admit that it goes against the conventional wisdom and there have been two questions that have popped up consistently that I thought I would take some time to answer:

Question 1: Why do you advocate paying down your mortgage and thus losing out on the tax savings from interest paid?


This is a great question to very controversial advice depending on who you talk to. If you would have asked me a few years ago I would had said this was absolutely a mistake. But my thinking has changed over the years. There certainly is the psychological aspect of being mortgage free.

The tax deduction and tax savings based on the size of a mortgage I advocate (2-3 times your gross income…MAX) is quite negligible in my opinion- especially when you break down the numbers.

Let’s assume between state and federal taxes I am in the 38% tax bracket and look at my tax deduction and tax savings over a 7 year period and see what I am really losing out on. And lets use real numbers for the mortgage which is $350,000 at 3.675%.

2015 – $12,622 interest expense, which results in a $4,796 tax savings (12,622 x 38%)
2016 – $11,846 interest expense, which results in a $4,501 tax savings (11,846 x 38%)
2017 – $10,683 interest expense, which results in a $4,059 tax savings (10,683 x 38%)
2018 – $9,117 interest expense, which results in a $3,464 tax savings (9,117 x 38%)
2019 – $7,140 interest expense, which results in a $2,713 tax savings (7,140 x 38%)
2020 – $4,944 interest expense, which results in a $1,878 tax savings (4,944 x 38%)
2021 – $2,409 interest expense, which results in a $915 tax savings (2,409 x 38%)
2022 – $157 interest expense, which results in a $59 tax savings (157 x 38%)

Total Interest Paid over 7 year accelerated pay down = $58,918 with total tax savings of $22,388 (58,918 x 38%)

vs. normal pay down (meaning no extra payments)

Total Interest Paid over 7 years on normal pay down = $86,703 with total tax savings of $32,947 (86,703 x 38%)

My tax deduction falls by $27,785 (86,706 – 58,918) resulting in an extra $10,559 in taxes (32,947 – 22,388) over the 7 years. However, don’t forget that I also saved $27,785 in interest expense during the 7 years due to the accelerated pay down.

On a net basis I actually have saved $17,785 (that is a 168% return on the extra $10,559 paid in taxes).

I don’t know about you but as long as the math works out like this, I would do this all day until I am blue in the face. And this doesn’t even include the other $171,000 in interest that I will save for the other 23 years I won’t be paying interest on this loan. And because I have an adjustable rate mortgage that could see the interest rate increase. If my loan were to increase to the maximum interest rate the savings would grow an additional $215,000 for a total savings of $386,000.


Question 2: Couldn’t you get a higher return in the market with the extra mortgage payments towards principal?


Of course there is the argument about earning a higher return in the market.

To this I would argue that this is just a portion of my total portfolio. I am not doing this (or recommending it) in lieu of making other investments in pre-tax and taxable accounts. Some people invest in bonds, I would prefer to pay down my mortgage and not touch bonds with a 10 foot pole (future post on this).

The stock market has had a magnificent run these past 6 years. But then again so have bonds. No one knows what the stock market will do or when it will have a major correction. But I do know that prices for stocks have gotten a lot more expensive over the past 6 years. I think we are entering into a period of very low performance in the market and that interest rates will remain low for an extended period of time.

The 3.675% return I get in the form of interest savings sure the hell beats a 2.5% return that 30 year Treasury bonds are paying. And if rates do go up then this strategy makes even more sense to me, because I have a 5/5 adjustable rate mortgage, which means my rate could go up if rates are higher in 2019. This just means my interest savings grows (see above).

I am and plan to continue taking plenty of risk in the financial markets. This is the safety portion of my portfolio, and I look at it as I would any other allocation of capital. As far as I am concerned I am earning a guaranteed 3.675% return. The market can’t promise that. But if the market does have a significant correction before I finish paying off the house then I would likely re-consider allocating more funds to stocks.


These are a few questions that I have received enough times to merit a separate post to address them.

Please let me know if you have other questions about this strategy or the rationale behind it. Or if you want to discuss if it might be right for you, I am more than happy to be a sounding board.

– Gen Y Finance Guy


 



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Comments

  1. These are excellent responses to the questions…and I agree with bonds – no thanks.

    It also means that when your mortgage is paid off, your biggest expense will be gone. That will help with lowering your yearly expenses and means that you won’t need as much money per month/year and could cut back on work.

    Or the money you save not pushing towards the mortgage could be put into the market and start earning you interest sooner than had you kept the mortgage. I am firmly with you on this one GYFG – the mortgage has got to go.

  2. I applaud you 100% for paying down your mortgage. Debt is an ugly thing and can keep people up at night. If I was in your shoes, I might follow in the same footsteps, but I also agree with others with low interest rates who decide to pay the minimum. After taxes a 4% interest rate on a mortgage is effectively less than 3% in most people’s cases, and while I know the past isn’t indicative of the future, the S&P 500 has returned over 11% including dividends over the past 25 years (1/1/90 – 12/31/14). Obviously dividends and capital gains get taxed as well, but that is pretty strong evidence to not pay down your mortgage, if debt doesn’t bother you and give you a headache.

    1. Author

      Smart lady Shimeka!

      As you saw above the tax break is less than the actual interest savings over the 7 year period.

      I think many people assume that the tax break is always larger than the interest paid.

      I will admit that there is a physiological aspect that you can’t really put a dollar value on of being debt free.

  3. Author

    @ Brian, Bonds just don’t interest me, especially at these interest rates. I am more inclined to allocate that money towards other investments either in the stock market or elsewhere once the mortgage is paid off.

    And as I mentioned in my response above, I consider the principal going into my primary residence as a substitute for a bond allocation. And currently the equity in my house makes up about 16% of my Net Worth.

    If this were to surpass 40%, I would seriously take a step back to re-evaluate the plan. However, I think I will be able to invest enough money elsewhere that this should not be an issue. Or if I see a great opportunity I can always stop the extra payments for a while. But right now it is only an extra $800/month. Next year it jumps to an extra $1,600/month.

    @ FF, I totally get your stance and others. But when I do the math the loss of $10, 559 is worth the interest savings of $17,000 in the short term. And in the long term $171,000 to $386,000 depending on what happens with interest rates.

    But I would point out that I am not doing this in lieu of investing in the markets. However, the stock market has had an incredible run and I think better prices are ahead. And I always keep cash available for these types of opportunities.

    There is a part of the argument that I have not addressed yet, and that is the opportunity cost of the $370,000 I will have locked up in my house when it is paid off at the end of the 7 year period.

    I will probably write a whole post dedicated to this. But let me say that I think there is a significant correction coming to the stock market. But I don’t know if it will happen in 2-months, 2-years, or longer. What I do know is that I don’t want to buy all time highs. I consider myself contrarion, and typically like to buy when everyone else is selling. Nonetheless, I should probably go through the exercise and do the math.

    Because as I like to say the path is all math.

  4. I agree that a tax deduction shouldn’t ever drive your decisions. Not only that, what is better, paying taxes on money you can keep (and most likely getting the standard deduction) or bragging to people at a party that you deducted a bunch o’ stuff. I which I choose.

    But, I keep my mortgage to build up my cash position. I’d really like $500k or so in taxable investments, then I’ll start thinking about paying off my mortgage. Mainly because I have plenty of money to sell my home and buy one for cash elsewhere, what’s the hurry?

    1. Author

      Hi Elroy,

      Its just as much a psychological reason as it is a financial one. I am not really in a hurry, I just think it is more than doable in 7-years. And I look at it as if it were a bond allocation. I will still continue to put money to work by maxing out pre-tax accounts and in the next 6-12 months we are looking to add a 2nd rental property to our portfolio.

      I am not afraid to take risk. But I personally would like to keep my leverage ratio at around 3X my annual salary (total debt/gross income).

      Lets just call this my plan B if I absolutely fail at life.

      Cheers!

  5. GYFG,

    I bought my house at in 1997 at age 26 and paid it off in 2010 at age 39. It was the greatest feeling unhitching that wagon off my back. I wouldn’t worry about tax savings, alternative uses for the money, etc. Each day I walk into a paid for house is a great psychological boost for me! Since then I have used the extra funds and focused on building my passive income.

    Stay relentless in eliminating debt!

    MDP

    1. Author

      Hey MDP,

      Congrats on owning your house free and clear. I am looking forward to joining the club.

      I totally agree with you, but I also want to make sure I provide the math for folks that need to see how it pencils out. I think so many people think that its impossible to do without living off of Top Ramen. Or they fall back on conventional wisdom of paying the minimum on the mortgage and investing the rest, and don’t forget about that tax deduction.

      In all honesty I had not even done the math prior to writing this post and reply. But it didn’t surprise me that the interest savings ended up being larger than the actual loss in tax savings.

      This is just as much a personal decision as it is a financial one. People can argue the opportunity cost to me all day until they are blue in the face, but its likely not to deter me. Especially since this is not in lieu of putting money to work in other higher (well potentially) yielding assets like stocks.

      Thanks for stopping by. Hope to see you again.

      Cheers!

  6. With a 30 year at 3.25, I personally would rather keep putting money into investments that pay a greater return than that, but I certainly understand the psychological appeal on that front. Being debt free feels great.

    1. Author

      Adam,

      3.25% is a fantastic rate. I don’t blame you for wanting to put money to work in high yielding investments.

      Its a very personal choice to pay a mortgage off early. It may not make sense to everyone. But I have found enough reasons to do so.

      I also don’t see nearly as much opportunity in the stock market after an incredible run these past 6-years. I think we are in for a sizable correction that will bring lower prices and thus better entries. But obviously neither I or anyone else knows for sure when that will be.

      I would admit that there is a scenario that would have me take a step back and reconsider the plan if the market was to correct significantly.

      But as I have pointed out a few times in these comments, I am still putting money to work outside of this strategy.

      And the feeling of being debt free is going to be amazing, can’t wait to have that mortgage burning party…yes I plan to have one.

      Cheers!

  7. We are also opting to pay off our 30 year mortgage very quickly rather than using that money in other ways. We should be mortgage free in August of next year- 4.5 years from when we closed on the house. I’ll take it!

  8. If you plan to pay off your mortgage in 7 years, why didn’t you get a 5/1 ARM and secure a lower rate for the first five? You would only be exposed for two years (two adjustments) and you do believe interest rates will remain low for an extended period of time.

    1. Author

      Hi AP,

      Great question and funny you should ask. When we first got our mortgage in February of last year, we did an FHA loan with plans to refinance out of it in about a year to get rid of the ridiculous PMI payments of almost $400/month.

      Things happened faster than expected and we were able to refinance out of the FHA loan in September of 2014 (or about 8 months). We then refinanced into a 5/5 ARM, this was before we had decided to pay it off in 7 years. Previously we were thinking 10-15 years.

      I am not too concerned about interest rates. But you bring up a good point. Because since refinancing and deciding to pay this bad boy off in 7-years, we are now considering another refinance towards the end of the year into a 5/1 ARM that would reduce our current rate from 3.675% on our 5/5 ARM down to 2.25 – 2.50% if rates stay where they are.

      Thanks for commenting.

      Cheers!

  9. Author

    Robin,

    That is absolutely amazing. Very impressive and good work!

    Any tips for others looking to pay down the mortgage early?

  10. I’ve heard of the concept of paying extra to your mortgage in lieu of investing in bonds…I believe it was in the boglehead forums. I think it can make sense. I’m not in that big of a rush to pay off a mortgage with such a low interest rate. I’m trying to put more of my extra cash towards investing in both the stock market and possibly rental properties. Although I do understand the psychological need to get rid of debt. I do pay a little extra towards my mortgage but focus more on investing.

    1. Author

      Hey Andrew,

      The great thing about personal finance is that there are so many roads that can lead to financial independence. It is awesome to see the diversity of approaches from other bloggers in the PF playground.

      I typically would be with you in putting the extra money that I am throwing at the mortgage towards stocks and other investments. But I personally think that we are due for a significant market correction, the problem is that I don’t know when it will happen. But Stocks are at all time highs and this has been an incredible run.

      It could be 2 weeks, 2 months, or maybe 2 years. We are going on 7-years strong with this bull market and the longest we have gone is 10 years without a recession. In a typical recession I think I remember reading that stocks have a tendency to pull back 20-40% in price.

      Worst case if I am wrong then I have a house that is free and clear. But I would also point out that this is in lieu of a bond allocation and not in lieu of other investments. I am still maxing out pre-tax 401K and IRA accounts. We also plan to add a 2nd rental property in the next 6-12 months.

      Thanks for stopping by. Hope to see you around in the comments more often.

      Cheers!

  11. Our current goal is to time mortgage pay-off at the same time as our anticipated FIRE date. Eliminating the mortgage for post-FIRE was a no-brainer as we think it will bring a huge sense of relief, plus the obvious reduction in required income. But we didn’t want to lose out on the earning potential of investments in the mean time. By coordinating the dates, we think we’ve achieved the best-case scenario. Mr. Maroon spent many hours running the math to check ourselves. We’d been debating ourselves to death before sitting down to see the numbers on paper. Someone will always disagree (and we had our fair share), but the rationale makes us the most confident in our decisions.

    Kill the mortgage while still maxing out our tax deferred accounts, plus a little extra saving here and there. Our current trajectory will put us paying it off in exactly six years and saving over $150,000 in interest. I just had to look it up to find that number, and WOW!! Craziness! Our approach is not for the faint of heart, but well worth it for us!

    1. Author

      Love it!

      One of the few ways you can get away with murder…LOL.

      Keep killing it Mrs. Maroon.

      Cheers!

  12. I noticed that the math for the investment portion was delayed until another post. I’m curious of the numbers over the next 30 years(7 year mortgage payment and 23 investing vs 30 year investing and 30 year mortgage payment). I know it favors the investment just with putting your money in early rather than later in big chunks for the most part.

    We are paying off our rental mortgage and also our owner occupied early as well, its our catalyst for early retirement. In our situation since both are essentially income producing(which pays off the mortgage early), our houses have essentially become dividend paying houses that become a large dividend once you pay off the mortgage early. The tax savings now is more of a bonus right now, but since it’s such a large part of our plan we are happy to pay off the home. We don’t care if the house goes down in value, but of course would prefer it not, because if we decide to get out of the landlord/property management we would receive our lump sum.

    1. Author

      Hey Even Steven,

      Yes I had to punt it off to another post. But I am really interested to put the math together for everyone.

      I think from a theoretical perspective you would be right that investing extra payments for the entire 30 year period instead of paying off the mortgage early probably wins out.

      Everyone in the personal finance space assumes that 8% returns win out and the history supports this of a long enough period. But I am not so sure it matters in a short time period. Especially if you put things into context with where the market currently is. We have had a tremendous run over the past 6+ years and the longest bull market before a recession is 10 years. I don’t think we will beat that record, but I could be wrong (I am not a fortune teller but I have my own thesis).

      And although many would argue against what I am about to say…but it makes sense to me. The value of your house is not going to stay static either, so I think you have to take that into consideration. I know its not as liquid as investments in the market, but I could sell it and go play some geography arbitrage.

      And I could turn my rental into my home base when we are not out and about traveling.

      There are a lot of variables to think about and this will likely end up being a monster post in excess of 3,000 words or more with lots of tables and charts.

      Glad you guys are finding a balance of what works for you.

      There are many roads to riches my friend.

      Thanks for stopping by.

  13. We just got our 30 yr mortgage about a year and a half ago, and it was a hard decision to make. I never had debt before and had the cash to buy the house, but decided to get a mortgage and use the cash to invest in the real estate market, which seemed hot and the best investment at the time. I hope I made the right decision. Having debt is definitely uncomfortable, and I hope to pay it off way before the 30 yrs. I agree with you that not paying off your mortgage just because you think you’re getting a great tax break is really not true. Great explanations!

  14. Hi GYFG –

    I am currently 35 and I think I’ve walked this path already, so let me share my experience and you and others can take from it what you will.

    My wife and I got married at 21/22 about 3 weeks after we graduated college. We were fortunate to both have jobs right away and only about $6k in student loan debt that we retired before it started accruing interest 6 months post graduation. She’s a teacher…I work in sales. After a honeymoon in Cancun, we moved in with my parents for 2 years (I know, I know). We only made about $70k combined those first two years but saved approximately 80 – 90% of our take home pay. We did a cheap vacation on our 1 year anniversary to DC and VA beach and we went out on Friday nights picking a different random place out of the entertainment book each week (b1g1 free), but other than that, we watched our money very tightly.

    After 2 years of extreme frugality, we had saved up $70,000, which allowed us to skip the starter home and put 20% down on the house we still live in today…12 years later. We put down $50k, used $10k to furnish it, and kept $10k in the bank which served as our emergency fund until we retired our mortgage completely.

    We bought the 2,900 sq ft house in 2003 for $251,000 with a 5% 15 year mortgage. The mortgage note was exactly $200k after the down payment. 3 months before we pulled the trigger on the loan, I switched companies and my income started to rise…I went from making around $35k to just under $60k…at 23, that honestly felt like a ton of money. Our plan at the time was to pay it off in half the time (7 1/2 years) by making a double payment on the principal. We tracked it religiously in an excel spreadsheet and would structure our payment so that our mortgage principal always ended on an even $100 increment (I.e. – $172,300)…it actually became a bit of a game to us.

    Well, good things happened with my career, I got promoted, got a few decent bonuses and we never lost focus…just kept living a “millionaire next door” lifestyle and plowing the excess onto the mortgage. The net result is that we ended up crushing our original objective and paid it off in 4 years, 3 months. Throughout that time, we always maintained the original $10k emergency fund, and I put a consistent 10%+ into my 401(k). When we took vacations, they were fun, but cheap (using hotel points from work travel, Priceline air tickets, etc) and we never drove a car that cost more than $5 – $6k until after the mortgage was gone. We obviously paid cash for the cars and had no other debt.

    At the end of the the 4+ year stretch when we were officially debt free and had several thousand dollars extra now each month, I will never forget what Ms. Wisdom Junkie said to me as we looked over the mortgage spreadsheet a final time. Her words were, “Well, we definitely did good, but I wish we could have paid it off sooner….we paid $38,000 in interest! That’s like flushing that money away and that’s almost as much as I make in an entire year!”. One of the many reasons she is the love of my life.

    So, here we are at 35 and completely debt free for the better part of 7 years. We have never, ever for one second regretted aggressively focusing on our mortgage first. It provides a huge piece of mind and sense of freedom…it is the first step in being truly financially untethered. I know there are lots of ways to get to the goal line, but I sleep like a baby knowing there are only assets on my personal balance sheet. We now focus on creating passive income streams that will support us indefinitely. I’m still with the same company that I made the leap to 12 years ago and they have been nothing but good to me. My annual bonus target now exceeds what my starting salary was when I joined. We save a lot, we give a way a lot, and we spend some now too. We are blessed beyond measure, but we’ve also tried to be good stewards along the way as well. I would like to semi-retire in about 5 years at age 40. I’do prefer to stay on 3 days a week with my current employer at 2/3 pay and serve in a special projects/consultant kind of capacity. Time will tell if that is a realistic path/option.

    When we first set out, we could have done a lot of different things, but ultimately paying off our house was an easy choice. We were guaranteed a 5% return and in 2003, the stock market was still a pretty scary place. The thing that really tipped me over the edge though was a piece of advice a work colleague imparted to this wisdom junkie. On the subject of being able to deduct mortgage interest, he told me this, “Enjoy the mortgage interest deduction while it’s there, but pay that thing off as soon as you can. People who spend $1 in interest to save $0.30 in taxes are bad at math.” So that is just what we did… 🙂

    Hope my story was helpful. It was fun writing it all out and reliving it.

    Wisdom Junkie

    1. Author

      Wow!

      Thanks for sharing your own experience with this Wisdom Junkie. Love that you wife was still bummed that you paid $38,000 in interest.Even though on a 5% 30 year loan for $200K you still saved approx. $149K in interest.

      Sounds like things are going really well on the job front as well. I hope the company you work for is willing to accommodate a part time schedule when you turn 40.

      Great story! Please come back and share more 🙂

      Cheers!

    2. Author

      By the way I think you win the prize for the longest comment ever left on this blog.

      Thanks again for stopping by.

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