The following is a contribution from James at Free In Ten Years. If you’re interested in contributing to Frugal Rules, please consult our guidelines and contact us.
Personal finance blogs are full of great tips to save money whether it’s by using coupons or by turning off lights in unused rooms. These measures are great for making small savings that add up over time. I’m all for this, but today I want to talk about something that will save you potentially hundreds of thousands of dollars – the magic of paying off your mortgage rapidly.
A typical mortgage of $250,000 at 6% interest over 30 years will cost $289,593.37 in interest alone. Consider that for a moment. It’s more than twice the original mortgage in interest. When you factor in the principal the total cost of the mortgage is $539,596.80!
It’s easy to get trapped into thinking that it’s fine to pay the minimum payment, but as you can see above, doing so will probably lock you into paying for your house twice over.
By increasing monthly repayments from the minimum payment of $1,500 to $2,000 you save $146,126.83 in interest and will be mortgage free 13 years and 7 months faster.
If you can double the minimum payments and pay $3,000 per month, a savings of $215,347.44 in interest can be had and you’ll be rid of the bank almost 21 years ahead of schedule!
But How am I Supposed to Pay so Much Into the Mortgage?
To achieve the type of savings I’m talking about, I recommend shopping for a mortgage that allows you to redraw without paying a penalty. This one of the questions to ask a mortgage broker as you’re shopping for the right one to fit your needs. The advantage of this service is that you can use your mortgage like a savings account (except it’ll earn you much more than your savings account!). It means that you can put your regular savings into the mortgage without worrying about not being able to access it again. Instead of your savings earning 1% in a bank account, you’ll be saving the 4%, 5% or 6% you’re currently paying on your mortgage.
It means that even if you redraw later on, you will still reduce the interest payable for the period the money is in the mortgage.
Even if you can’t get a mortgage with free redraw facilities or an offset account, you should still do everything you can to pay more than the minimum into the mortgage. Make savings elsewhere if you have to – for example, if getting rid of your cable means an extra $50 per month into the mortgage, then you really should consider whether you will enjoy watching South Park reruns more than ridding yourself of your mortgage payment sooner.
Similarly, you should consider putting windfalls into the mortgage. Large lump sums paid into a mortgage towards the beginning can save mountains of interest by the end.
Using the example above, if you paid only the minimum payments, but paid $20,000 into the mortgage in year 1, you’d save $81.503.73!
My Extreme (Early Retirement) Example
I have the somewhat ambitious (or perhaps crazy) plan to retire from paid work in ten years. I started my journey to early retirement with a net worth close to zero, a mortgage and an average income. I’m on track to retire in about eight years and to pay off my mortgage in three years by being extremely frugal.
It is really easy to get into the mindset that it’s impossible to make the necessary savings so that you can contribute more to the mortgage – I understand that because I used to think like that. Overcoming that sort of negative thinking is the first step on the path to being mortgage-free.
If I can live on 30% of my relatively modest income then I’m sure you can manage 75% of yours if you want it badly enough!
The Practical Steps to Slashing Your Mortgage
Firstly, I strongly encourage you to do the calculations to see how far away you are from being mortgage-free based on your current repayments. Stop reading now and go do it! Once you figure it out, work out how much faster you’ll get there if you pay 20% more and how much that is per month. Then try 50%. Get excited by the numbers. Challenge yourself to slash years off your mortgage.
Get excited by the savings. Then work out how to put the necessary money into the mortgage.
Once you are excited by the idea, you’ll find a way to do it. Start by comparing the happiness you get from your discretionary spending budget to the potential happiness of being mortgage-free. Replace expensive pastimes like going out to the movies with a home game night with family or friends.
Ride a bike to work and pocket the fuel money. The list of money-saving possibilities are endless when you have a fixed goal in mind.
- Know the date you’ll pay off your mortgage based on your current repayments.
- Aim to slash years off your mortgage and how know much you have to save to meet your new target.
- Be committed to your budget and become a frugality machine, starting with your discretionary spending budget.
- Shop around for a mortgage with free redraw facilities.
- Shop around for a mortgage with a better interest rate.
- Consider putting windfalls into the mortgage.
Extra mortgage payments compared to other investments
If you live in the United States, then you are living in a period of extremely low mortgage interest rates which can make the prospect of a swift repayment plan less attractive. But, consider the alternatives. If you put your money in a savings account it’s going to be lucky to earn 1%, and who knows what you’ll get in the sharemarket – whatever you do earn will be taxed and not guaranteed.
The benefit of repaying any kind of debt is that it’s a certain return. If the 3.5% interest rate on your mortgage is a higher interest rate than you could get in your savings account then you owe it to yourself to think about the plan I’ve laid out above.
There are numerous mortgage repayment calculators which will let you see the time and money savings that can be had from a faster repayment schedule. Bookmark your favorite and play with it to see all of the various scenarios.
You might not aspire to an early retirement like I do, but hopefully you can see the benefit of mortgage slashing. I encourage you to look into it. It might just save you $100,000.
The following was a contribution by James at Free in Ten Years. Free in Ten Years is a blog run by James which documents his path to early retirement. He has set a goal to be retired within ten years, before his 38th birthday. He plans to get there by living on 25% of his income or less and investing the rest.
Editors note: James brings up some valid points on ways to reduce the life of your mortgage. I am not as vigilant about paying ours off, but there can be some significant savings by paying more than the minimum payment on your mortgage annually.
Photo courtesy of: Christa Richert