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our best money decision

Lose The Mortgage: Our Best Money Decision

by Phia @ Freedom 101

One of the questions we are often asked by readers, is what was our best money decision? The one that made Financial Freedom a reality?

In truth, the sum of all the actions we took, both large and small, is what got us here. But if I had to narrow it down to just one thing? Hands down it was our decision to pay off our mortgage.

Making that choice was the first step we took towards the possibility of Financial Freedom. Before we knew anything about FIRE, or thought it was something we would ever be able to do.

When we made that decision, we weren’t looking to leave our jobs. We just 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.

We wanted to choose to go to work, not have to go to work.

How Can Paying Off Our Mortgage Be Our Best Money Decision?

Yes – we’ve read all those same finance books. The ones that tell you never to pay off your mortgage. That investing is always the better choice. 

But in finance, always and nevers rarely apply.

We knew we had to take the financial knowledge we had built and look at the totality of our individual circumstances. Including our own personalities and attitudes towards debt.

We started by looking at our debt situation. At the time we had only four sources of debt. A small car loan at 0% interest, our principle residence mortgage, and two rental property mortgages.

We were tempted many times to pay off the car loan for the psychological gain of eliminating one source of debt. But we knew if we kept making the basic payments it would be paid off around the same time we would be able to pay off our mortgage.

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. Ouch!

What About the Tax Write Off’s?!?!

An additional consideration when evaluating our debt was that, in Canada, we can’t just write off the mortgage interest of our principle residence.

The exception to this rule applies to portions of the loan being utilized to generate income or invest. (IE: a basement suite, space for a home business, Smith Manoeuvre etc, but only proportionate to the space/funds being used to generate the income.)

In a 3000 sqft home, if you have a 1000 sqft basement suite, 1/3 of your mortgage interest becomes eligible as a tax write off. But of course there are limits on how much of your principle residence can be utilized for income purposes.

Meanwhile ALL of the expenses associated to the rental properties were tax write offs. Both were cash flowing, and it absolutely didn’t make sense to pay those down.

So while we had some tax savings in relation to mortgage interest on our primary residence, because we had both a suite and a small side hustle, it didn’t offset the exorbitant amount of interest we would pay over the life of our mortgage.

The Opportunity Cost

But we still had to contend with that age old argument presented in nearly every finance book. And reverently postulated by much of the online personal finance community.

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. We absolutely could.

Over the long term (20-25 years) it was likely that we would create substantially more wealth by sitting tight, paying our base mortgage payment, and putting our excess cash into higher growth investments.

But this wasn’t about having choice in 25 years. This was about having choice as quickly as possibly. Freeing up cash flow, and claiming the psychological win of having ZERO debt. For two people who hate having debt hanging over our heads – the value of that win was BIG.

We believed that we would work harder and be more efficient at paying off the clear goal of eliminating our mortgage 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.

It’s worth noting that it’s impossible to calculate the opportunity costs of not paying off our mortgage. Both monetary and non-monetary. How would that have changed our subsequent decision making, and the path we pursued?

Set Clear Goals And Know Your Limitations

We calculated a reasonably aggressive goal to pay off our $600,000 mortgage in 7 years. Putting us at what we dubbed as Freedom 35 (34 for me!).

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 one, understanding 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.

IRD’s are less relevant if interest rates are trending upward. In which case you would likely end up paying a penalty equivalent to 3 months interest. But IRD’s are hugely significant when interest rates are trending down.

The Mortgage Destruction Strategy

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.

While an extra two payments per year doesn’t seem like much – it actually equates to YEARS taken off your original amortization, and tens of thousands of saved interest payments (depending of course on your original mortgage amount and duration of term).

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.

**Tip: 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 sub-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 small ritual for us, but a huge motivator. We loved doing it, especially at the beginning when small increases resulted in tens of thousands of dollars in savings.

Getting Creative

Once we saw the savings we were raking in, we were hooked. That’s when we started to really up the ante.

After each 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 re-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.

If we got one time payments for overtime 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 for us to not only max out our weekly payments, but to make lump sum payments as early as we could.

Why?

The 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 generally structured, the majority of the interest is paid on the front half. 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% (if your lucky).

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.

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 had reached the max allowance for increasing our weekly payments. We couldn’t increase the payment any further without incurring penalty.

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, much bigger.

What About Emergencies? Job Loss?

Now a lot of people would argue that they would rather have the money accessible.

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 didn’t ignore that, and 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.

2) In conjunction with the mortgage vacation option, we kept one years worth of basic additional living expenses 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 25% of our income each month to ensure our retirement nest egg would steadily build.

Was It Working?

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 live in an area that was experiencing immense market growth. Growth that as individuals we believed was unsustainable and was likely to level off. If not experience a correction.

We decided it was an opportune time to sell our rental properties and utilize the available equity to maximize our annual lump sum payments on our mortgage. As well as up our savings rate.

So over a 8 month time frame we sold each property.

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. But 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 pay off your mortgage.

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.

The Bigger Win – And Why It Was Our Best Money Decision

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 were perfectly capable of living an enjoyable life on much less than what we were making.

Increasing our payments forced us to make them before our lifestyle purchases. We were inadvertently paying ourselves first.

Plus we got to 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 made us pause to identify what we really got value from. Prioritize our spending, and evaluate where we spent our time.

And opened our eyes to just how creative, motivated and disciplined we could be when we were working towards a common goal. 

While I would never suggest that paying off your mortgage is the right call in every situation, for us it was absolutely our best money decision.

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Money Mechanic April 27, 2020 - 10:56 am

I’ve heard the argument for both sides of this debate for quite awhile now. I find myself having an internal debate, my brain making a pretty good case against my psycological side and vice versa. This is a very personal decision that has so many more variables than just the math. I like how you mentioned paydown is a tangible goal, that’s definitely important.

I think I’m an advocate for the balanced approach. Which is probably a bit of a cop out…But It’s what we have done, and I think it offers a good compromise. We aggressively made additional payments when the mortgage was high, and rates were high. As you said, the beginning is the most important. However, we were still mindful to save enough to max our TFSAs. No doubt we are in a privileged position to be able to do that. But my point is that paydown and investment growth ideally would be done together. If you can come up with the balance where you get the benefit of paying off your mortgage in 12 years, AND you get 12 years of compounding I think you’re further ahead. For people that don’t have rental income, who payoff a mortgage but don’t have any other assets. I could see it being difficult to then have to start ‘paying’ the same amount as the mortgage every month to try and build an investment portfolio. Your cash flow situation has not improved. Perhaps at that point people don’t invest, because it’s not a necessary expense.

Anyway, I’m not trying to start a debate. I completely agree that the psychological rewards are huge. It’s just important for each person to weigh what the reward looks like in the bigger picture. As you stated, it was very important to you and Mike. I think it’s important for us too, I just fight with myself about it all the time!! LOL

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phiafreedom101@gmail.com April 27, 2020 - 1:58 pm

Hey MM! Thanks for checking out the post. I don’t think your answer starts a debate at all – I think it underscores just how personal this decision is, AND that there is no one right answer that fits everyone’s circumstances.

Like you, we were fortunate enough to be able to invest into our tax advantaged accounts throughout our mortgage pay down. I agree that is the ideal scenario. If someone has to choose between those two options, I think it’s even more crucial to for them to do a full assessment of their goals, time frame, and their money personality when it comes to debt and savings habits, in order to reach the optimal answer for each individual situation.

What I don’t believe, is that the answer can be reached simply by asking what scenario will produce more money. If it was that easy, personal finance wouldn’t be so personal :). Thanks for reading, and for your very thoughtful comment!

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