Lose The Mortgage

One of the questions we get asked the most, after how did we retire so young, is what did we do that made the biggest difference in reaching FF. In truth, the sum of all the actions we took, both large and small, is what got us there. When I look back at some of the things we did that seemed small, and do the calculations of how much money we saved over the long term, those small steps turned out to be pretty huge.

But if I really had to choose one thing that we did that made the biggest difference, it would have to be the choice we made to pay off our mortgage. Destroying our mortgage caused us to further build our financial acumen, reduce expenses, and find ways to generate new income. It also gave us a joint goal that we worked feverishly to achieve.

Making that choice was the first step we made towards the possibility of early retirement, before we knew anything about early retirement. When we made that choice, we weren’t looking to leave our jobs anytime soon. We just knew that we were no longer loving our career choice as much as we once had. We also knew that our housing costs were a huge portion of our monthly expenses, and if we eliminated our mortgage payments, we would have more choice.

In it’s infancy, our decision was based on eliminating debt to give us choice. Not that we even intended to exercise that choice by leaving our jobs, we just wanted to choose to go to work, not have to go to work.

We had read all sorts of finance books, some arguing the benefits of paying off your mortgage early and many arguing against it. But we knew we had to take the financial knowledge we had built and look at the totality of our individual circumstances in order to make the best decision. We started by looking at our debt situation. At the time we had only two sources of debt. A small car loan at 0% interest, and our mortgage.

Although we were tempted many times to pay off the car loan for the psychological gain of eliminating one source of debt, we knew if we just kept making the basic payments it would be paid off around the same time we were able to pay off our mortgage. Not to mention that from a numbers perspective, it made no sense to use our available capital to pay down a loan with a 0% interest rate. (Frankly, the dealership had already worked the cost of the interest into the vehicle purchase price, so we were paying it no matter how quickly we paid off the loan. Finance lesson #182, 0% interest usually means that some other cost of the item has been inflated to account for that interest. It still pains me to think I fell for it back then.)

An additional consideration when evaluating our debt was that, in Canada, we are unable to write off the mortgage interest of our principle residence. The exception to this rule applies to portions of the residence being utilized to generate income. (IE: a basement suite, space for a home business etc, but only proportionate to the space being used to generate the income. So in a 3000 sqft home, if you have a 1000 sqft basement suite, 1/3 of your mortgage interest becomes eligible as an expense. But of course there are limits on how much of your principle residence can be utilized for income purposes.) So while there were certainly some tax savings available as a result of having both a suite and a small business, it didn’t offset the exorbitant amount of interest we would pay over the life of our mortgage.

Then we had to contend with the age old argument presented in nearly every finance book. Could we invest our money elsewhere and make a higher return comparative to the interest rate we were paying on the mortgage.

The short answer. Yes, we absolutely could. Over the long term (20-25 years) it was likely that we would make substantially more money by sitting tight, paying our base mortgage payment, and putting our excess cash into higher growth investments. There was no doubt that the opportunity cost of putting our money into our mortgage instead of those higher returning investments could be substantial.

But this wasn’t about having choice in 25 years. This was about having choice as quickly as possibly. For us, we calculated a reasonably aggressive goal to pay off our mortgage to be 7 years. That was a huge difference in terms of time frame, and an even bigger difference in the psychological impact that we would achieve by paying off our mortgage and eliminating all debt. We also strongly believed that we would work harder and be more efficient at paying off the clear goal of eliminating our mortgage in 7 years than the more abstract goal of saving and investing over 20-25 years.

When we looked at the financial and psychological factors, it led us to a very clear answer. We were going to pay off our mortgage.

Our mortgage was structured so that we were allowed to double our monthly mortgage payment in addition to paying  up to 15% of our original mortgage amount in an annual lump sum, all without any penalty for pre-payment. Whether you are about to buy a home, or already own, reading the terms and conditions or your mortgage is imperative. Ensuring you have ample penalty free pre-payment options is key if you intend to pay down your mortgage at an accelerated speed. Similarly, knowing your penalties for early payment is also important. If you find yourself in a position to pay out your mortgage entirely, getting stuck paying an interest rate differential (IRD) can equate to tens of thousands of dollars in early payment penalties. IRD’s are less relevant if interest rates are trending upward, where you would likely end up paying a penalty equivalent to 3 months interest, but IRD’s are hugely significant if interest rates are heading down.

For us, the interest rates had decreased from the time we acquired our mortgage, but breaking the mortgage to secure a lower rate resulted in a huge IRD penalty, in the neighbourhood of $40,000. We did the math to see if we would recover that cost in saved interest if we paid the penalty up front and moved to a lower rate, but it wasn’t worth it.

So we wanted to avoid IRD penalties and stay within the pre-payment limits of our mortgage terms. When we had started the mortgage we had elected to make accelerated weekly payments. This translated to two extra weekly payments per year, over and above what would normally be paid in monthly instalments. IE: if you’re paying $2000.00 monthly, vs $500.00 weekly, at the end of the year the monthly payments will total $24,000 while the weekly would total $25,000. Also, if you are paying $2000 monthly, you’re going to accrue interest on the entirety of the principle portion of your next payment for the next 30 days. If you are paying weekly, you are going to reduce that principle amount every seven days, thereby steadily reducing the accruing interest throughout the 30 day period.

Small changes like this may appear insignificant, but when you make the change from monthly payments to accelerated weekly, depending on where you are in your mortgage, it often shaves years off your total amortization. And when you’re looking to take a 25 or 30 year mortgage down to say 10 or less, a few years is a big step in the right direction.

For us, just selecting accelerated weekly payments vs. monthly at the onset of our mortgage took nearly 4 years off our total amortization. If you are looking to pay off your mortgage and don’t know how to start, changing the payment frequency is an excellent first step, and most mortgages allow you to do so without any associated fee’s.

When we were satisfied with our payment structure, we looked at how we could maximize our pre-payment options, staying within the limits of our mortgage terms. We started small, first increasing our weekly payments by just $50.00, later by a $100, then $200. Our goal was to max out the available double-up of our mortgage payment. As a general rule of thumb, if you double your mortgage payment, you will pay off your mortgage in approximately ten years or less. We knew that our accelerated weekly payments, in tandem with a double up payment, would put us in the 9 year range.

Every single time we made a payment increase we would sit at the computer together and put in the numbers, waiting eagerly for the computer to spit out exactly how much our modest increase would save us in interest over the life of our mortgage. This was a huge motivator, and we loved doing it, especially at the beginning when small increases resulted in tens of thousands of dollars in savings.

Seeing those huge savings motivated us big time. It also made it much more obvious that if we had just steadily chipped away at our mortgage over 30 years, we would have paid HUNDREDS of thousands of dollars in interest. That was hundreds of thousands of dollars of our hard-earned money. Money that we could spend on other things.

It’s so easy to forget about that when you are just chugging along paying your mortgage over the long haul. You think, hey it’s okay, I bought my house for lets say $500,000, it was a great deal and I’m just slowly paying my $500,000 plus a little interest. But what about when you look at what you actually pay over the long term. If someone told you that you would end up paying around $850,000 for your $500,000 home as a result of that interest, would you feel like your house was worth it? Depending on your interest rate, that’s the hard reality of the numbers.

After each payment increase we would head back to the budget board and find more ways to cut our monthly expenses. As soon as we found some savings we would turn around and increase our weekly payment to reflect those savings. Down to the penny. One of the keys was that we never made the money we “found” available to spend, which meant we never ran the risk of inadvertently inflating our lifestyle or having the money just disappear on stuff.

When one of us got a promotion, our mortgage payment was increased to reflect the entirety of the raise. When we got one time payments for overtime worked or we sold no longer needed items for the house, that money went directly into a separate savings account to put towards our annual lump sum payment.

It was important to not only max out our payments, but to make lump sum payments as early as we could. Why? Those lump sum payments were what was going to take us from a 9 year pay off date, to a 7 year pay off date.

The way mortgages are structured, the majority of the interest is paid on the front half, and the principle on the back half. At the beginning of your mortgage the interest portion can easily be in the range of 90% of the total payment, with principle making up a meagre 10%. But your interest is calculated on the outstanding principle, so the earlier in the life of your mortgage you can make lump sum payments on the principle, the more savings you are going to realize. The interest savings of a $20,000 lump sum paid in the first couple years of your mortgage is going to drastically outweigh the savings you might achieve if you made that same $20,000 lump sum in the second half of the life of your mortgage. So timing was important for us. We wanted to make those lump sum payments sooner rather than later, even if they were small.

About a year into our goal we found that we had reached the max allowance for increasing our payments. We couldn’t increase the payment any further without incurring penalty. So at that point anything extra went directly into our savings account to put towards the annual lump sum amount. That’s when our lump sums started to grow much bigger.

Now a lot of people would argue that they would rather have the money accessible, because if we had been half-way through this process and one or both of us lost our jobs, or we had a significant emergency for which we required cash on hand, no matter how much we might have paid down that mortgage we would still be stuck making the base payment each week.

We addressed the potential for disaster in a few ways. 1) Our mortgage was structured in such a fashion that at anytime we could take a “mortgage vacation” equivalent to the amount of pre-payments we had made. It didn’t take long for our pre-payments to equate to years of not having to pay our mortgage if we found ourselves in a precarious situation. 2) In conjunction with the mortgage vacation option, we kept one years worth of basic additional living expenses available as an emergency fund, and 3) We didn’t adjust the retirement savings rate we had set prior to our goal of paying off the mortgage. We continued saving and setting aside a decent amount of money monthly to ensure our retirement nest egg continued to steadily build.

Our baby steps compounded quickly, and we were decimating our mortgage. We were well on track to pay off our mortgage in our 7 year time frame, but then an opportunity arose for us. We had both been able to keep one of our prior homes and  turn them into rental properties, and we lived in an area that was experiencing immense market growth. Growth that as individuals we believed was unsustainable and would ultimately correct. We decided it was an opportune time to sell both of the rental properties and utilize the available equity to maximize our annual lump sum payments on our mortgage.

That equity sped up our overall plan by two years, and what was once a 7 year goal was achieved in 5. There is no doubt that we were very fortunate to have our rental properties, and also lucky in terms of timing and the market, but we recognize that not everybody is going to have access to an asset of that nature. If you don’t have a couple rental properties to fast track your plan, don’t let that discourage you, and don’t dismiss the idea that you can achieve FF. Remember, even if you can just double up your payments, you are on track to pay off your mortgage in about 10 years or less.

Aside from the financial gains of choosing to pay off our mortgage, the biggest unplanned factor in all of this was that it allowed us to understand what we really wanted our lifestyle to look like, and that we could live an enjoyable life on much less than what we were making. Increasing our payments forced us to make those payments before our lifestyle purchases and experience what it was like to live off 20-25% of our income. It allowed us to understand that living a simplified life was actually MORE enjoyable for us, not less.

It also made us pause to identify what we really got value from, prioritize our spending, and evaluate where we spent our time. It took living that way to have the confidence to know that we would be happy in “retirement”, even if we weren’t rich in the traditional sense.

It opened our eyes to just how creative, motivated and disciplined we could be when we were working towards a common goal. Without experiencing all this first-hand, I don’t think either of us would have felt comfortable leaving our jobs.

While I would never suggest that paying off your mortgage is the right decision for every situation (in fact there are many situations where it could definitely be the wrong decision), in our circumstances it was absolutely the right move. As the saying goes, hindsight is 20/20, and with the benefit of hindsight, paying off our mortgage is a decision neither of us would ever change.

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