When considering the idea of mortgage paydown, first thing’s first. Any super high-interest debts (like credit card balances) should be paid off first. For all other debts, I’m a fan of using the cash flow index method to prioritize debt repayment. You may find the mortgage falls low on the list since typically, those high payments are spread over a long, 30 year period. Once all of your immediate debt priorities are paid off, you may want to explore how to pay off a mortgage in 5 years or less.
With our debt situation, admittedly I’m bending the cash flow rules a bit. We have a large chunk of student loans remaining from Mrs. Cubert’s postgraduate studies. Since the loan rate is only 2% (roughly the rate of inflation), it doesn’t make sense to pay more than the minimum monthly payment.
Those payments are about a quarter of the monthly mortgage we owe, so it’s not a big hit to our cash flow. We can opt to tackle this loan after cubicle life when the monthly minimum payments start to go up.
Is It Smart to Pay Extra Principal on a Mortgage?
Many well-informed folks would argue that even after you’ve paid off all of your high-interest loans and obligations, it simply doesn’t make good financial sense to pay off a mortgage. But for us, paying off the mortgage means one less cloud hanging over our heads financially. Hard to put a price on that.
There are more objective reasons. Paying off the mortgage is like a hedge against the stock market. You’re getting a guaranteed 4% (or whatever your mortgage rate is) return with each payment. In the long term, saving tens and even hundreds of thousands in mortgage interest does not suck.
For my cubicle escape to work, I need to reduce or eliminate unnecessary monthly payments from the budget. Losing the mortgage means we’ll have $800 more each month in the kitty.
We’ve been pretty aggressive with our mortgage pay off strategy since we started making extra payments in early 2016. The goal was to have it paid off fully by January of 2019. We almost made the target, but it took another six months to finally pay that last penny.
Not having a mortgage payment improves our cash flow substantially. We recoup $745 per month now and that’s just about enough to cover our grocery bill.
We played our cards well with the 5-1 ARM we used when refinancing our mortgage in 2015. Having a soft deadline of February of 2020 (when the ARM expired) gave us the incentive to get the job done and pay off our biggest debt obligation. I know, ARM financing can be dangerous. Part of what caused the financial crisis of ’08 was the dreaded adjustable-rate mortgage.
Here’s what can happen if you let an ARM mature: You start with your new house and things are great, payments are affordable. Then, year two or three or five rolls around (depending on the duration of the ARM) and BAM. Your interest rate surges and your monthly payment surges along with it. Shorts. Soiled.
Using an ARM (Adjustable Rate Mortgage) to Accelerate the Payoff
We knew what we were getting into back in early 2015 when we signed the papers with Wells Fargo. I was inspired by a tactic Mr. Money Mustache shared: Refinance at a very low rate and then aggressively pay down the mortgage. This speeds up the process since the lower rate increases the amount of principal paid down each month. Presto magic!
Going with a 5-1 ARM, we gave ourselves five years to get the job done. The beauty of refinancing back in 2015 was that back then, rates were super low. We locked in at 2.625% – a rate that effectively made half of our monthly payments go straight towards the principal.
In full disclosure, our house originally cost $245,000 and was purchased way back in 2004. However, because I was a peon at work with very few nickels to my name (and single with no roommates), I had to use a HELOC to manufacture a large enough down-payment to avoid mortgage insurance. My net worth hovered around zero.
A side note: I highly recommend the tactic of taking out a “piggyback loan” to help you avoid having to pay mortgage insurance. Private Mortgage Insurance can cost you anywhere from around $100 to $300 per month, depending on the size of your mortgage. It’s a total sunk cost. Better to take out a home equity line of credit (HELOC) alongside your mortgage to meet the 20% equity to value requirements necessary to avoid PMI.
This HELOC financing strategy helped me avoid PMI payments, but it also kept me treading water for several years on the mortgage. Progress was DOG SLOW. After I paid off that initial HELOC balance, I later used it to pay off my car loan. This used to be a smart tactic for arbitraging interest on debts, and getting a little more mortgage interested deducted on taxes! In 2013, I started using the HELOC to make down payments on rental properties.
How to Pay off Your Mortgage in 5 Years or Less
You’d think that by 2015, having “owned” this house for 11 years, I’d have put a serious dent in the mortgage. Sadly, you’d be wrong.
The thing with a 30 year fixed mortgage is this: If you let the mortgage mature, you end up paying a TON of interest. In the first decade alone, you’ve barely put a dent in the principal. Let’s take a look at what my $220,500 mortgage ($245K minus 10% down payment) looked like on a 30-year schedule:
On this schedule, by the time the house is paid off at Year 30, I will have paid a handsome sum of $255,422 in interest alone. Whoah. Remember, I paid $245,000 for this place…
The starting point for our mortgage pay off project, beginning in the winter of 2015, was right around $190,000. Hard to believe that after 11 years, I’d managed to pay down just 30K of the original loan. That’s what happens when you sleep-walk through a 30-year fixed-rate mortgage.
From the time our super low 2.625% interest 5-1 ARM refinance kicked in, to about this time last year, we simply made the minimum monthly payments. I had a plan, after all, to shed some higher interest student loans first, then tackle the mortgage.
In July of 2017, our mortgage balance had shrunk to $177,000. The new lower rate was already making serious headway into our principal. It was at this point that we started to aggressively hammer away at the mortgage. All of our extra income after expenses would be put towards extra mortgage payments.
Fast forward to July 2018. Our balance now stands at $91,000. For the first time, we’re looking at a whiteboard on the fridge with five digits instead of six. It feels nice, but until that board shows a big fat doughnut hole, I won’t be satisfied.
It’s Okay to Adjust Plans If Opportunities Emerge
Opportunity costs abound. What if we instead put our extra dollars into the stock market? Equities have been on a stellar ride these past several years. We’d love to maybe put more of our eggs into the real estate basket. There are other options besides paying off the mortgage if you’ve got extra money to work with.
In 2018 we hit a bit of a speed bump on the path to a zero mortgage. Our Airbnb Experiment, specifically. There was the $25,000 down payment, followed by roughly $15,000 in refurbishing and setup costs. If not for the Airbnb “distraction”, our remaining mortgage would be right around 50 grand.
Despite that increasingly profitable diversion, we’re still on-track to knock out the mortgage before our 5-1 ARM expires in February 2020. Just in time. After that point, the rate could easily shoot up to 4%, or even 6% over the next few years.
Nevertheless, the amount of principle we’ve been able to pay down during the low rate 5-year span more than offsets any future year increases. Read this article from the Financial Samurai to get a deeper education on how ARMs can work better for you than 30 year fixed mortgages (tread lightly and go in eyes-wide-open!)
Paying off a 5/1 ARM in 5 Years
- If you decide that paying off your mortgage in five years or less is for you, consider refinancing to a 5-1 ARM so your regular payments take an even bigger bite out of the principal.
- If you’re buying a home and can’t put down 20%, look into taking out a HELOC up-front to avoid paying PMI (private mortgage insurance).
- Remember to pay down all of your other debt first! Unless those debts have 2% or less interest, the mortgage should be the last debt you target for paying off.
- Don’t let good opportunities pass you by. If a real estate rental or Airbnb investment catches your eye, consider pausing your mortgage pay down. Even if your ARM expires, rates will not shoot up so high that you can’t make payments. You can always refinance.
- Bonus: Make sure you’re still contributing at least up the employer match in your 401K. In my book, paying off the mortgage is somewhat of a hedge against the market tanking. However, an aggressive mortgage pay-down strategy shouldn’t come at the expense of free money (401K employer match).
Part of our financial journey is removing obstacles to a life of freedom and choices. If you own a house or have owned one in the past, you know all about the stress of having a mortgage hanging over your head.
If you do your research, you’ll find a lot of conflicting advice about the financial wisdom of paying off a mortgage early. Some of the best, most well-researched articles are themselves conflicted. You don’t come away with a clear-cut answer. That’s what makes mortgage pay off a somewhat tortuous decision, especially for those seeking Financial Independence and Early Retirement.
Counterpoint: Why You Shouldn’t Pay off Your Mortgage Early
You could spend a good chunk of time whittling away at the principal, but at any point in time, regardless of how much principal is left, the bank can legally foreclose on you for delinquent payments. In a disaster situation where you’re left without a job and can no longer make payments, all that effort to pay down the mortgage is wasted.
The bank owns your home until every last penny is paid. Foreclosure is REAL.
Common advice suggests you put your extra money after mortgage payments into the stock market and realize a yield of up to 9%. You could then put that money into real estate rentals, where returns might eclipse 20%.
So why not just hang onto the mortgage? Skim off the margin between your mortgage rate of say 4%, and a theoretical stock market yield of 9%, gaining you a 5% return? That’s not including the tax deduction on mortgage interest…
(That’s another aspect of this riddle. Remember that your wise accountant will factor any mortgage interest deduction in your tax returns. If you pay off your mortgage, you lose this deduction.)
You never know where the stock market is headed. Over the long haul, it will grow, but by how much and with what dips we can’t predict. There could be another Great Recession looming for all we know.
If cash flow is important to you and retirement is near, you may not want to count on a steady market return. If you’ve got 20 or 30 years until retirement, then the market is a strong choice.
Why Have a Mortgage at All?
Why not simply rent and avoid all the hassle? I respect this view and understand why many in the early retirement community lean towards renting over owning. For me, I simply enjoy having a house to customizing and work on. Sadistic, I know.
There is some peace of mind not having to worry about what the landlord intends to do with the house long-term. The landlord could opt to sell your house despite your lease agreement. It happens all the time, and especially nowadays in a supercharged seller’s market.
By owning our house, we don’t have to worry about rent increases. We don’t have to worry about having to move if the landlord chooses to sell.
I would suggest the following approach if you live in a market with extreme housing costs (e.g., San Francisco, L.A., NYC): Rent or move.
So, friends, what do you think? Now that you know how to pay off the mortgage in 5 years, will you take the plunge? Please comment below!
Postscript 7/3/19: We’ve paid off our mortgage early in May 2019. No champagne or anything, just a progress tracker wiped clean off our fridge whiteboard. One less cloud!