PAY OFF YOUR MORTGAGE, a homeowner’s dream… The 30 year fixed mortgage is the most popular but that is 360 months of payments. A 15 year fixed mortgage payment is still 180 monthly payments. Many homeowners pay a little extra here and there to reduce the length of their mortgage but with out a real plan. I am here to share with you three options to Pay Off Your Mortgage Early but you may not be ready yet. First, you must finish steps 1-8 of your Net Worth Millionaire Plan before you are properly prepared to attack your mortgage. Those steps include the following:
- Calculating your Net Worth (step 1)
- Writing out your Financial Goals and Monthly Budget (step 2)
- Saving for your Emergency Fund (steps 3 & 6)
- Investing in your Retirement (steps 4 & 7)
- Paying off all your Consumer Debt (step 5)
- Saving for your kid’s College (step 8)
Keep reading if you want to become mortgage free….
There is much debate on if and how you should pay off your mortgage. Through thorough research, proper money management and some trial and error, I have gained a lot of experience on this topic. My wife and I bought our first primary house in 2006, bought a vacation home with my in-laws in 2008 and sold and upgraded our primary residence in 2015. We refinanced both our first primary residence and our vacation home once. Also, we are currently on this step (9) of our Net Worth Millionaire Plan. Now that you know my background, I recommend three options to Pay Off Your Mortgage Early.
You will need to consider a few things before you decide on a method;
- It must be automatic-set it up to be deducted
- The more money you add the quicker it is paid off
- Do not pay a fee to do this
- Use a mortgage calculator & an investment calculator
- This will assist you in your calculations
The 3 options to pay off your mortgage are as follows:
Option 1-Invest Extra Principal Payments & Build Wealth
This is my favorite option and the one I am currently using. Invest your extra principal payment in the stock market through a mutual fund or index fund. You will continue this until your investment matches your remaining loan balance. When they match, you financially own your home. This provides you with a higher return, more liquidity and the ability to continue to build wealth because your money is in the market.
This should provide you with a higher return because mortgage interest rates are at historic lows. Here is a personal example from 2006:
- 5.875% – my interest rate in 2006
- 25% – my tax bracket in 2006 (can deduct interest on taxes)
- 5.875% x 25% = 1.469% (amount your interest rate is reduced)
- 5.875% – 1.469% = 4.40% (true interest rate)
- 4.40% – minimum goal of my invested money(after taxes)
My true interest rate and the minimum goal of my invested principal needs to exceed 4.40% (after taxes) to be worth it. Not to mention, this money is liquid and accessible since it is not stuck with my mortgage company.
Now, once your investments match your mortgage amount, it’s time to build wealth. Continue to pay your mortgage and invest your extra principal payments. Every month you are building wealth because your mortgage principal is shrinking, the amount you already have invested is increasing and you are adding to it.
FINANCIAL EXAMPLE:
- Mortgage balance = $100,000 (mortgage principal payment reduces by $1,000 per month)
- Your Investment = $100,000 (you are investing extra principal payments of $1,000 per month)
- Continue to pay off your mortgage and invest your extra principal payment
- After 1 month you would have increased your Net Worth by $2,000
- ($1,000 toward your mortgage & $1,000 invested)
- New mortgage balance = $99,000
- New investment balance = $101,000 (assuming market stays the same)
- After 12 months (1 year)
- Mortgage balance = $88,000
- Investment balance = $112,000 (assuming market stays the same)
Once your mortgage balance is $0.00, your investment balance will be $200,000 (assuming market & principal payments stay the same). Now you are mortgage free and have $200,000 invested and have started/completed step 10 of your Net Worth Millionaire Plan. If you want to build more wealth, continue to invest but now add your $1,000 mortgage payment. Now stay the course and continue to WIN!!!
In the event that you become nervous about your finances because of carrying this mortgage balance or riding the market as it goes up and down, remember that you are already did or are doing the following:
- Using on a budget
- Saved an emergency fund
- Contributing 15% of your income toward retirement (plus company match)
- Paid off all consumer debt
- Saving for college
- Invested enough money to pay off your mortgage
Option 2-Invest Extra Principal Payments & Pay Off House
This option is very similar to option 1. You will invest your extra monthly principal payment until your investment matches (include your capital gains tax) your mortgage pay off amount. Sell your investment and pay off your mortgage. You are now mortgage free and able to begin to build wealth. Therefore, the difference between option 1 and option 2 is what you do after your investment matches your mortgage pay off amount. In option 1, you continue to pay off your mortgage and invest your extra principal payment every month. In option 2, you will pay off your mortgage then begin to build wealth by continuing to invest your extra principal payment and by adding your mortgage payment to it. Let me show you what it will look like:
- Mortgage balance = $100,000 (mortgage principal payment reduces by $1,000 per month)
- Your Investment = $100,000 (you are investing extra principal payments of $1,000 per month)
- Pay off your mortgage, continue to invest your extra principal payment and add the monthly mortgage amount.
- After 1 month you would have increased your Net Worth by $2,000
- ($2,000 invested)
- Mortgage balance = $0.00
- New investment balance = $2,000 (assuming market stays the same)
- After 12 months (1 year)
- Mortgage balance = $0.00
- Investment balance = $24,000 (assuming market stays the same)
The pro’s and con’s of this option are as follows:
On the positive side:
- Your are completely debt free including your house
- Less stress
- Able to start building wealth quickly
- No debt payments
- Financial flexibility
On the negative side:
- Less liquidity than option 1 (money is with mortgage company)
- You will build wealth slower
- Starting wealth building with $0.00 (instead of $200,000-ex. option 1)
- Compounding interest will take time to be seriously noticed
Option 3-Add Extra Principal Payments Toward Mortgage
This option is when you add extra principal payments toward your mortgage balance. Make sure you note that you would like your extra payments to be paid toward principal and not interest. The mortgage company will apply it toward paying your interest and that does not help you. You want to pay down your principal balance. Many people prefer this option because it’s less risky and not subject to the volatility of the stock market, as well as they can see the loan balance decreasing every month. There are a few ways to pay extra on your mortgage:
- Biweekly mortgage payments
- Instead of 12 monthly mortgage payments; pay 26 half-payments (13 monthly payments)
- Make quarterly extra mortgage payments
- Every 3 months pay an extra mortgage payment (16 monthly payments)
- Pick a pay off date and add that amount
- Let’s say you want to pay off your mortgage in 10 years
- Calculate the monthly amount needed to do so
- Add that amount to your monthly mortgage payment
- No need to refinance
- Let’s say you want to pay off your mortgage in 10 years
- Find every extra dollar in your budget and apply it monthly
- Let’s say you can afford to apply $200 toward your principal payment
- Automate this payment
- Add all or a percent of any extra income
- Overtime, tax refund, gifts, side job(s), inheritance
PERSONAL EXAMPLE:
My wife and I, have personally used option 1, option 3 and are back to option 1. As soon as we bought our primary residence in 2006, we immediately started investing extra principal payments into mutual funds and kept track of our progress. In 2013, we already had 15% of our remaining mortgage balance in mutual funds and we were still adding to it. Coupled with having already saved a proper emergency fund, investing into retirement, saving for college, being debt free except our primary mortgage and our share of a vacation home. Also, the stock market was starting to rebound from the lows of 2008-2009.
CHOICES:
In February 2013, we decided to aggressively pay off our primary mortgage in 5 years (February 2018) with option 3. To begin with, that means we would have paid off our primary residence in 12 years and be well on our way to paying off our vacation home too. However, something remarkable occurred with this option.
We were so focused, hopeful and determined that we were able to find money from our budget. Also, the stock market and the economy were coming back, a few work bonuses, my small side business was doing well and we poured every extra penny into our mortgage. In September 2015, we were about 15 months away from owning our home outright (over 1 year early). However, between our invested extra principle payments and cash saved, we had enough money to pay off our primary mortgage. I only recommend option 3 if you are laser focused on paying it off within five years.
After 32 months of focus, September 2015, we decided to move because we wanted a bigger house, be closer to work and a better school district. You might be thinking, how could you move after all that work to pay off your mortgage. It was actually because of this tremendous effort, that we were able to make this decision. In November 2015, we bought a house in an amazing town with a 34% down payment on a much bigger and more expensive house.
At the present time, we have enough invested extra principal payments to pay off our vacation home. However, we are still paying our monthly vacation home mortgage, which is reducing the principal and investing in the market to pay off our primary residence. We are well on our way to paying off our new home.
PAY OFF YOUR MORTGAGE-ACTION STEPS
- Complete steps 1-8 of your Net Worth Millionaire Plan
- Decide between options 1, 2 or 3
- Automate your option
- Be AGGRESSIVE!!!
To summarize, reaching step 9 of the Net Worth Millionaire Plan is a great accomplishment but keep working hard to be debt free including your home. Regardless of which option you choose, automate it and stay focused. Following a plan will prepare you to be financially secure and provide you with more opportunities.
