I mentioned in prior articles that we decided to pay off our mortgage early. When we first embarked on our financial independence journey, we didn’t plan to do this. And in fact, we have not yet started making extra principal payments to accomplish this goal. I’ll get to why in a bit. But first, here is a short rundown on why we did not plan to pay off our mortgage early. We purchased our condo when interest rates were at historic lows for a 15 year term. Our condo is relatively inexpensive (for reference, it represented about 16% of our total annual spending in 2018). We made a 20% down payment, leaving a relatively low mortgage balance that is already under six figures. These factors mean that the financial incentives to pay off our mortgage are slight. If we paid it off tomorrow, we wouldn’t even save $15,000 in total interest. Our mortgage is not a hair on fire emergency. Some might even argue that the numbers create a financial disincentive to pay off our mortgage. It’s true that our money invested in the market has returned amounts much greater than our mortgage interest payments over the last five years. But that assumes the markets will generate a certain minimum return over the payoff period. Returns are never guaranteed.
If it doesn’t make financial sense, why bother?
Early in 2019, we started thinking about paying off our mortgage because it is psychologically satisfying. There’s nothing quite as motivating as watching a debt balance fall. It is regular and predictable with a fixed rate loan. By contrast, market forces affect our investment balance more than our contributions. Some months, our investments are way up, some months they hardly increase at all, and sometimes they drop. The psychological satisfaction of debt payoff is a purely emotional reason for us.
Our second reason is also rooted in emotion, but it has a financial aspect. Paying off the mortgage will free up several hundreds of dollars of cashflow each month. Slaying that debt will eliminate our single biggest fixed monthly expense. Remember how I said we still need to decrease our annual spending by 11% to get to our expected retirement spending number? Not having a mortgage payment gets us there (and then some). Paying off our mortgage is the only way we can make this level of spending reduction without a big lifestyle shift. The emotion underpinning this reason is security. We feel more secure when our fixed expenses are lower. The financial reason is that a smaller nest egg is needed to cover a lower spending amount. As one of our contingencies, we will continue to estimate our annual spending near current levels to account for unknown necessities like health insurance or housing if we choose to sell our condo (either to relocate permanently or to nomad). If those necessities don’t materialize, we can use the surplus on fun splurges like travel or restaurants.
How we plan to pay off our mortgage early
Our early payoff plan will have two phases. We want to keep our investment contributions at present levels in order to reach our nest egg target on schedule. This is why we haven’t started paying extra on our mortgage yet. The difference between our income and spending simply doesn’t allow for extra mortgage payments at our current savings rate. Our 2020 budget looks better thanks to our ongoing efforts to reduce discretionary spending. It is also likely that one or both of us will receive at least a small raise in January. So, we anticipate at least an extra few hundred dollars every month to throw at the mortgage. We’re trimming down things like travel and restaurant spending to make more room for the debt paydown. This is Phase 1 and it will be slow going. That’s okay, though, because this slow phase serves our purely emotional goal of the satisfying effect of debt paydown.
Starting late this year or early in 2020, we will commence Phase 1. Any additional “found” money will go towards our mortgage principal instead of being used to increase our stock market investment contributions. This means that any bonuses, pay raises, or surpluses earned through spending reductions, will be invested as additional principal payments on the mortgage, rather than invested in the market. Phase 1 serves our emotional goal of psychological satisfaction. It is helpful, but it will likely not be enough to fully pay the mortgage by 2024 when we plan to quit working.
Phase 2 will take effect when we start hitting big financial independence milestones. Once our taxable, non age restricted funds reach the full target amount (anticipated sometime in 2023), we’ll suspend or reduce additional contributions. We will continue contributing to age restricted retirement accounts for tax optimization purposes. The magic of compounding means that our market-invested retirement funds will continue to grow, even as we reduce our contribution amounts. We’ll invest the money that was going to our taxable brokerage account in paying down the mortgage principal. When that happens, the mortgage will disappear in a hurry. It’s hard to estimate how long this will take because we aren’t sure how much progress we’ll make in Phase 1 of the payoff plan. If both of us changed jobs for big pay raises, we might not even need to implement Phase 2. Even if Phase 1 is a flop or is never implemented, the longest reasonable timeframe for the aggressive phase is one year.
Our multi-phased plan allows us to leverage the higher returns we expect the market to deliver. We won’t save much in mortgage interest with this plan, but then again, we’re not paying a lot in interest either. The real benefit is the extra cash, or reduced spending, that we’ll enjoy right from the beginning of early retirement. Those first few years of early retirement are the most vulnerable to sequence risks, so it makes sense to be able to keep our spending as low as possible.
Does an early mortgage payoff serve our goals?
Even our early mortgage payoff plan requires some delayed gratification! It reminds me of paying off my student loans. The situations are similar, where the low interest rate and manageable payment do not warrant an aggressive repayment. Instead of indulging that desire to just be done with the mortgage and declare ourselves debt free, we’re making the smarter financial choice.
Our plan serves our big goals, even if it doesn’t satisfy our immediate emotions.
Tell me your thoughts on mortgages and debt freedom, even in the absence of early retirement. Are you paying off your mortgage early? Avoiding a mortgage altogether?