How to Pay off Your Mortgage
How to use overpayments to eradicate mortgage debt
Paying off your mortgage early is one of the most powerful steps you can take towards financial freedom, but when it comes to overpayments— here’s why it pays to be the Tortoise, not the Hare.
“Debt is normal — be weird” — Dave Ramsey
There is a lot of talk about mortgages. A lot of talk about how much you should borrow, what term is most appropriate and how not to overstretch yourself. Like most things in personal finance, mortgages are personal, you need to do what’s right for you, but if you need a basic plan here’s one that I’ve found a good guide:
- The shorter the term the better. If you can’t afford the mortgage on a 15-year term, consider if you can really afford it at all.
- Whatever percentage of monthly income you think is appropriate to borrow, it’s probably too much. Personally I think 25–30% of monthly income is appropriate — after all, income can come down, and rates can go up.
- Fix your rate. The amount of times I’ve heard “well interest rates are low, now is a great time to borrow” and it makes me cringe. Yes, interest rates are low, but that’s exactly what makes them more likely to rise over the life of the mortgage.
Should you even pay off your mortgage early?
Yes. Whilst this may at first glance appear to be a strange question (after all mortgages are debt and debt should be paid off right?) there are a lot of people out there that will tell you that you shouldn’t. They will tell you that while interest rates are low, you’re better off attacking more expensive debt with any excess income that you have, rather than paying down your mortgage.
They will tell you that mortgages are just a necessary evil of life, that everyone has one and that spending all your hard-earned money paying it off is an inefficient use of your money.
Whilst I’m not in the business of saying why others are wrong to say what they say, personally these arguments are not for me, and I also don’t think they are helpful for most people.
For most people, our mortgages represent our single biggest expenditure, and I’d much rather work towards getting rid of it so I can live in the bliss of being mortgage-free and am able to invest later, rather than scrimp together to invest a little now so I can say “I’m investing”. After all, who needs a mortgage hanging around any longer than they have to, even if the rate is low, for now at least.
Don’t get fed to the lions
Mortgages are liabilities, there are no two ways about it. Life can change, and change quickly at that. So, at the end of the day, it pays to think about mortgages in terms of risk.
Imagine a hungry Lion who has been stuck in a cage all day. Now imagine walking into said cage, having the cage door slam behind you and realizing you’ve got juicy steaks strapped to you arms and legs. Things are looking good for Lion, not for you.
T Lion represents life’s risks— unemployment, medical uncertainty, economic recession, the list goes on. Obviously the name of the game is to not get eaten. Your mortgage term is how long you are in Lion’s cage, and your mortgage rate is the steak.
The more steak strapped to your, and the longer you’re in the cage — the greater the chance you get eaten.
By paying off our mortgage early, not only do we reduce our time in the cage, but we also don’t have to hold the steaks. We can get on with our lives with one less lion to think about.
Slow and steady wins the race
Generally speaking paying off your mortgage can only happen one of three ways. We either get unexpected income we can throw at the balance, we reduce our monthly expenditure in order to free up some cash, or we go out and find a way to increase our income.
Obviously, doing all three is perfect, doing two is great, but just doing one will still help you make massive progress towards becoming mortgage-free.
When I started writing, my long term goal was to pay off my mortgage with whatever I earned (I know, big dreams right), I wanted to tuck all the pennies away and one day be able to turn around and pay off my mortgage. Whilst this is a nice idea, I started to wonder if it was really the most effective way of getting rid of my mortgage? It turns out it wasn’t.
I decided to look at a mortgage overpayment calculator to see if small overpayments I can start today were more or less effective than saving that money up till it was a sizeable amount, and dropping it on my mortgage in say, five years time. Here’s what I found.
I looked at a basic set of circumstances — a $100,000 mortgage over 15 years with a rate of 4%. I looked at what happens if you overpay by $100 a month first and if you do nothing for 5 years and then pay $6000, the equivalent of 5 years at $100. Here’s what I found.
On the right, we have the $100 a month model, on the left we have the $6000 model. Attached to each is a column showing how much is paid towards the mortgage principle each year.
The little green box in the middle indicates the amount paid off that year including the $6000 lump sum.
The immediate thing to notice is that if you pay $100 a month you shave about two and a half years off the term of the mortgage, by waiting to pay the lump sum off this ends up being less than a year.
At the end of the day the prize is getting rid of mortgage debt as soon as possible, so on the basis of this alone we can see that small and steady pays off in the long run, but there’s more — interest.
If you don’t know how mortgages work, most of what you are doing in the early years is paying off interest, the actual balance is barely being touched to start with. The more you overpay, the more you are contributing to the actual balance of the mortgage, and the less you pay overall in interest.
To be exact, if you pay off $100 extra a month you save $5512 in interest, if you wait to make a bigger payment and pay off $6000 at the five-year point you only save $2809.
So, to sum up, here are the results of paying off $100 a month extra:
Mortgage paid off 2 years and 4 months early and $5512 saved in interest.
And if you pay off a $6000 lump sum at the five-year point:
Mortgage paid off 11 months early and $2809 saved in interest.
Theory v Life
Clearly these calculators can only provide models. Even if you stick to a plan rigidly I’m sure that in the end, the story of how you paid off your mortgage would be different from what the calculator would have shown you. What they can’t model is the uncertainty of life, they are limited in their flexibility.
Their benefit though is in highlighting things for us, things that can form the basis of a plan. For me, here’s what the model above shows me:
If we pay off a lump sum of $6000 after five years we are worse off than if we pay $100 a month over that period. Now, if we paid another $6000 at the ten-year point the difference narrows (that second lump sum saves about nine months and $1200 in interest), but that isn’t the point.
The point is that $100 a month is much easier to find that $6000 over five years, let alone every five years over the life of a mortgage. If we leave $100 set aside, trying to build it to $6000 it often gets swallowed up by life. If we pay $100 a month, we’ve paid it, we’ve budgeted for it and we’ve made our little win for the month. The point is we win a behavioral and a psychological battle.
Get Busy Thinking
To me, the benefits of overpaying your mortgage monthly, throwing whatever extra you find towards it, is much more beneficial than trying to save up a bigger balance for lump-sum payments. It’s more beneficial by way of numbers, and it’s also easier on the mind. Add this to income from a side hustle and a reduction in living expenses and you can really make headway fast.
When all is said and done here, the most important thing is that you start thinking about it, that you start making a plan.
Everyone’s circumstances are different, and there’s no one-stop-shop for taking you from the financial normalcy of having debt, to financial freedom and flexibility in life.
The onus is on us as individuals to do the digging, think about our circumstances and decide which ideas we think will best help us achieve our goals — and ultimately execute on those ideas.
I believe that the above example is a good insight into how mortgages work, how we can make massive differences in what we pay in interest and how long we pay interest for b throwing whatever extra we have a month towards our mortgage.
“Facts are stubborn things” — Ronald Reagan
Reagan wasn’t wrong — you can’t get away from the facts, and when it comes to mortgage overpayments the facts show how beneficial this approach is.
The real benefit though is that this approach provides us with the one thing that we all really want, It provides us with the change to start making progress, and the chance to start making it today.