By purchasing under our means and analyzing our financial situation, we paid off our home in 4 years so we could be debt free.
Our focus is now on making our money grow and work for us rather than paying off multi-decade debt.
Although I'm using this post to talk about how we paid off our home in 4 years, what I'm really hoping to illustrate is how we looked at our financial situation holistically to eliminate our biggest piece of debt.
Debt is something so many of us become comfortable with in our lives without acknowledging what a powerful destroyer of wealth it is. Car loans, home loans, credit cards, student loans, the list goes on.
Debt gives our money leverage. It allows us to leverage our current finances to purchase things that we can't currently pay for up front with the promise that we'll pay back the debt with interest over time. It's that leverage (or gearing) that makes getting into debt so attractive.
Using leverage to buy things is sometimes unavoidable, like in the case of buying a home. Generally we don't have the money on hand to pay for our house up front and so taking out a mortgage is the only option. Unfortunately that means taking on significant debt and ultimately paying far more for our home than the original price.
The first issue with debt is the obvious one. In the end we pay more for something than what we would have without taking on the debt. In most cases, the total amount paid is substantially more over the life of the loan than the original price tag.
In fact, it's worthwhile comparing apples with apples. Calculate the total amount that you'll pay for something over the term of the loan compared to the original cost. Scary.
The second issue is slightly less obvious. For as long as we have debt, we're either not building wealth and financial independence or doing so substantially slower. We're allowing ourselves to become accustomed to paying off debt rather than investing that money to buy back our time and enjoy the freedom that comes with it.
Anyway, back to how my wife and I paid off our home in 4 years.
The first thing we did was think about our needs as a family which included considering cost per use which is something I've talked about before.
At the time it was just me and my wife along with two small dogs and the possibility of having a child in the future. So we needed a 3 bedroom house one of which would be used as a home office since I work from home. The last bedroom would be used as a baby room if we decided to one day take the leap into parenthood. Lastly, we needed a garden for the dogs.
In the end we found a house that we loved and which fit the bill. No more, no less. Just what we needed to live comfortably. The key was that the purchase price was well under our means. Based on our income at the time, we could have bought a house for almost twice the value of what we chose, but we didn't need anything more.
Buying below our means allowed us to:
We love our house and it's all we need. Sure we could have purchased something far more extravagant but the stress of walking such a fine line each month with our finances and sitting with multi-decade debt was just not worth it for us.
By the way, we've since had a child and are making good use of that last bedroom. Here's some thoughts I had a couple days after his birth for passing on good financial habits to him.
The next thing we did was to analyze our Mortgage interest rate versus investment growth potential elsewhere.
Mortgage interest rates vary a lot from country to country. Where we live interest rates of around 10% are common. Our interest rate ended up being 9.45%. Even if rates where you live are much lower, it's still worthwhile thinking about these things from all angles.
A reasonably conservative expected return from the stock market over the long term is somewhere around 8%. This varies dramatically from year to year and country to country, but over the long term (I'm talking multiple decades), using 8% as a ball park figure is reasonable. Of course it may be a roller coaster ride along the way with some years being really scary.
With an average 8% market return on investments and a 9.45% mortgage interest rate, it was clear we needed to focus on our mortgage. So we decided to direct most of our income after expenses towards paying off our home loan while directing a smaller portion towards investments.
It's common for the automatic debit order for mortgage payments to come off on the 1st day of each month and for the interest amount to be calculated daily.
Since our salaries were typically paid on the 25th of each month that would mean several days of higher interest while our salaries sat idle in our bank accounts.
We therefore changed the date on our mortgage debit orders to be the 27th of each month. Tightening up those debit order dates meant less interest owed every month.
In our country we have something called an access bond / mortgage. What this means is that our mortgage can be used as a bank account. Once money is deposited into it to pay off the loan, it can be withdrawn again if necessary.
The interest payable on our mortgage was calculated daily and so it benefited us greatly to put in as much money as possible as early as possible. If it turned out we needed some of the money, it was quick and easy to withdraw some of it.
So in addition to the required minimum that was automatically debited from our account on the 27th of every month, we also transferred our entire salary into the account manually (excluding what we needed for expenses and investing).
Thanks to having an access mortgage we felt comfortable transferring every last dollar into the account each month so that our regular bank accounts never had more than a couple hundred dollars in them.
Every day when the interest payment was calculated, we knew it was as low as it possibly could be.
Something we've been pretty good at avoiding over the years is lifestyle creep. As our salaries increase and bonuses are received, we don't rush to find ways to spend that extra money but choose to rather increase our investments and mortgage repayments.
My wife received a few great bonuses from her job while we were paying off the mortgage which she immediately transferred into the loan.
So that's it. Just by looking at our financial situation holistically and applying the above strategies, we paid off our home loan in 4 years. As soon as our home was paid off, we started redirecting that money every month into our investments and retirement accounts.
We're now in a position where we are completely debt free, own our house and contribute about 50% of our monthly income to investments while we continue our journey to financial independence.
Article by Brendon @ Money FI