You become financially independent the moment your investments yield enough money every month to cover your expenses. You can then decide to stop working and enjoy life, although most people simply decide to slow down a bit, while remaining active. If you are financially independent in your early 40s or even 50s, the perspective of laying in a hammock sipping cocktails all day long for the next 50 years is actually a bit depressing. But in order for your investments to cover your expenses that early, you need to focus on two things:
- Spending less
- Saving more
The less money you need in order to support your lifestyle every month, the quicker you can quit your day job and focus on what is really important to you. Getting rid of your mortgage seems like a great idea in order to get rid of one of the biggest lines in your budget. But does it really make sense?
Paying off your mortgage early is a dream for many. In this current climate of low interest rates, it might not be your smartest money move. Over the past 20 years, the S&P 500 has averaged a return of 8% annually, if you reinvested the dividends. That means you can pay off $1,000 of mortgage at 3% and save $30 in interest over the next 12 months, but you also miss out on the opportunity to potentially invest $1,000 at 8% and make $80.
Pay Off Your Mortgage Early
I don’t blame you. I did just that and actually bought a little house with cash. I would have invested in the markets if I had my eyes solely on financial independence, but sometimes it’s not just about money. I wanted the house to be mine, and not the bank’s. I wanted the freedom to know that whatever happens, a market crash, a health problem, anything, I had a roof over my head. I find the 360 monthly installments to be a mental drag. So I bought my freedom. And if you want to as well, here are a few tips to pay off your mortgage early:
1. Look for a refinance
Interest rates have dropped drastically over the past few years. Even a 0.25% rate drop can save you thousands over the life of the mortgage. This is one of the easiest ways to shave a few years off your mortgage.
If you have a $200,000 mortgage at 4% over the next 25 years, your payments are around $1,055 per month. Getting a 3.75% loan will lower them to $1,029 per month, saving you just under $8,000 over 25 years. That is a great return for a few hours of your time and bank appointments.
2. Make extra payments
If you have refinanced your mortgage to 3.75% but keep paying $1,055 per month instead of $1,029, you could save $4,883 extra in interest and pay off your mortgage 12 months early. It won’t affect your lifestyle since it was what you were used to paying anyway. Another strategy (if your mortgage provider allows it) is to make two bi-weekly payments instead of one monthly payment, effectively paying 26 half payments, or 13 monthly payments every year.
3. Throw all savings at your mortgage
Every dollar you save, put it in a specific account and once or twice a month, pay it toward your mortgage. There are so many ways to save money, and little amounts do add up. $5 here, $35 there… there are even apps to help you save money, or bank accounts that will automatically transfer extra funds past a minimum balance into savings. When you work to pay off your mortgage early, you can’t get the funds back if you are tempted to buy something instead, unlike with a savings account.
4. Throw lump sums too
With our example $200,000 mortgage, you usually repay $1,055 per month. If you get a Christmas bonus or a check from your parents for $1,000, and overpay your mortgage just that one time, you will save $1,695 in interest and become debt free 2 months earlier. All for making less than one monthly payment.
5. Snowball other debt payments
You should always pay your higher interest debt first, such as credit cards or personal loans. But if you were used to paying $200 per month for your personal loan, just roll over that money when the loan is repaid and pay off your mortgage instead. Regular $200 monthly over-payments on our mortgage means a whopping 6 years less of payments, and $31,027 saved in interest.
Deciding to pay off your mortgage early is not the fastest way to financial independence, but it is indeed a great security for your retirement. With a few little tricks like these, you can become mortgage free years earlier.