The Joys Of A Paid Off Mortgage
By Rob Wrubel, CFP®, AIF®
Last week, three families we work with were excited about the prospect of paying off mortgages on their primary residences.
I have seen and helped clients reduce their mortgage payments over the last few years with the ever reducing average mortgage interest rates. Now, I am seeing families focused on eliminating those payments.
One family had made paying off the mortgage a significant short-term goal. They were sick of the monthly payment, tired of worrying that a reduced income could impact their lifestyle and the threat of having to sell the house in an emergency. They took whatever extra money they could each month and sent it to the mortgage servicing company as a payment towards principle – reducing the time period of the mortgage each time. It looks like the last day of 2012 will be the last mortgage payment they will pay. They will own their home free and clear.
Talk about a thrill for them and for me.
Now, the family will get to think about their plans for the next stage of life. The husband and wife still work and are still saving for retirement. They now have choices with the money they used to send to a debt payment. They can increase the retirement contribution to build more security or retire earlier than expected. They can enjoy life today with travel, activities and purchases they were putting off until they had enough money. They can give to charity and support causes they believe are important.
None of this could be possible with the outflow of income going to the mortgage payment. There would not have been enough extra money each month to put towards the next set of meaningful and important family goals.
How you handle your mortgage is one of the key financial decisions you can take. Too big a mortgage payment can sink your financial plans. Renting forever and not having a mortgage can actually work if you put your savings into an account that builds financial assets. You do lose the chance to create an asset while having a roof over your head if you rent.
Financial planners use rules of thumb for helping to determine how big a mortgage payment should be. Generally, the accepted wisdom is the payment should not be greater than 25% of take home pay. This payment should include taxes and interest in my opinion.
In today’s environment, many families can buy more house than in the past as a result of low interest rates. The trend seems to be different – families are finding smaller and even more affordable houses to reduce the risk in their lives and the additional expenses that come with larger homes.
Take the following example. A loan of $400,000 costs a family just over $2,000 per month in principal and interest on a 30 year loan at 4.5%. Historically, that looks like a fantastic rate. This year, the rates just seem to keep dropping (thank you Federal Reserve). Bankrate.com shows the average rate in the US today at 3.46% and a quick rate search shows APR rates between there and 4%. A rate drop from 4.5% to 3.65% means a savings of about $200 per month.
Interest rate decreases alone in this example save a family $2,400 per year. A family focused on paying off the loan can create even more family savings. Paying off the mortgage creates close to $24,000 per year in additional funds that can be used for anything they desire.
Reviewing total interest paid also makes it interesting. Accelerating payments cuts the total interest paid as the time horizon of the loan decreases. A family will pay about $330,000 in total interest on a 30 year loan with an interest rate of 4.5%. Doubling the loan payment each month cuts total interest to about $100,000 paid and takes about 20 years off the length of the loan.
Most people cannot afford to double the overall payment each month. Adding just 20% more cuts interest by $107,000 total and the time by nine years. Throwing extra money each month pays off and increasing that amount as earnings increase will just move the process that much faster.
What would you do with an extra $10,000, $24,000 or more each year? How you would handle the reduction in stress when you have the freedom to live in your house that you own outright? Life gets interesting when we realize that the debt we carry has real impact on the ability to enjoy life.
We focus on your goals and aspirations during the planning process. Paying off the mortgage could be one technique to use to get you to live your dreams faster.
Rob Wrubel CFP®, AIF®, is a Senior Vice President, Investments with Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.