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The times sure are a-changing.
As mortgage rates around the world climb inexorably higher on the back of central bank interest rate hikes, everything in the housing market seems to be changing, in ways that continue to surprise us.
Today’s reader case is a great example of this. What should have been a fairly straightforward analysis turned out to be anything but.
Read on to find out why.
Hey FIRECracker & Wanderer,
I am a huge fan of you both and inspired by your journey. Absolutely LOVE,LOVE, LOVE your book.(Did i mentioned that I love your book!?). Going on 10 times that I’ve listened to the audiobook and each time I listen to it, it’s like the first time all over again.
Anyways let’s delve into my dilemma. I believe that I have started my journey a little late. We don’t have much in terms of savings or investments, as we were quite financially illiterate in our early years and have finally hopped aboard the financial independence train. Now it is due time to play catch up. I am definitely a believer that it is better late, than never. With a little assistance from you , I think that achieving our goals will be possible.
Let me give you a little background. I am 40, an Administrative Assistant, living in Alberta making 45,000 per year and my partner works with a non-profit organization earning approx. 47,000. We have a daughter who is now attending school online, due to the pandemic. We have decided to keep her online as she is thriving and this also keeps a few costs down.
Here are the deets:
- Gross: 45,000 + 46,924.80/ Net: 36,972 + 37,440
- We keep our finances separate, so my partner deposits his portion (2074.00) into my account on a monthly basis
- Monthly expenses $3,011.00.
- Debt
- Credit Cards paid in full:0.00
- Fixed Assets
- House purchased at 189,000
- Balance 135,000
- Monthly mortgage 880.00, property tax 140.00, condo fees 300.00
- 3.5% rate
- 2 older cars paid for in full
- Investments/Cash
- RRSP 10,000.00
- Cash 2,000.00
- Emergency Savings 2000.00. Adding 200.00 per month until we reach 3-6 months of expenses
Note: We would like to pay off our mortgage as quickly as possible, therefore, we will begin to set aside 1,400.00/month towards our mortgage for the next 6 years, then reallocate this to investments. 600.00/month will currently go towards investments, until mortgage is paid and then this contribution will increase to 2000.00/month
Your insight would be truly appreciated.
Late Starter
This reader case initially caught my eye because they calls themselves “Late Starter,” don’t have 6-figure STEM salaries, and have a kid. According to haters of FIRE, these should be enough to disqualify you from ever becoming FI and I wanted to see if they were right.
It was also interesting because when the reader initially wrote to us, mortgage rates hadn’t started rising yet, so the environment they wrote to us and the environment we’re in now are completely different. Even so, they asked a really interesting question: Should they shovel as much money as they can into their mortgage so they can pay it off quicker?
It was probably just a normal, mundane question six months ago, but today, it’s super relevant for a lot of people. Because up here in Canada, the mortgages rates we can get aren’t locked in for 30 years like in the US. Instead, they’re typically sold with 5-year terms, at the end of which the remaining balance gets renewed at whatever prevailing interest rates are at the time, which of course means that the nice comfy 3.5% fixed rate mortgage LateStarter has will be replaced by one that’s way more expensive in just a few years. How will this affect their journey to FI, and how does dumping more money into their mortgage to pay it off faster affect this dynamic?
As we always like to say on this blog, let’s MATH THAT SHIT UP!
The Numbers
| Summary | Amount |
| Income | $36,972 + $37,440 = $74,412 (net) |
| Expenses | $3,011 per month, $36,132 per year |
| Investible Assets | $10,000 + $2000 + $2000 = $14,000 |
| Debt | $135,000 (mortgage) |
I always love reader cases that challenge the haters that say FIRE is only for 6-figure earning tech bros or it can’t be done if you have kids.
You can, if you’re smart about your money. Which is what this family is. Right off the bat, you can see that their savings rate is very high. With net earnings of $74,412 and expenses of $36,312 per year, they’re saving $74,412 – $36,132 = $38,280. This gives us a very impressive savings rate of $38,280 / $74,412 = 51%, despite the fact that they say “we were quite financially illiterate in our early years.”
Yes, their net worth could be a bit higher based on their age, but given their salary and their ability to save over half of it while raising a kid, that’s no easy feat. Most impressively, they bought a house within their means and don’t have credit card or student debt. That’s already ahead of most homeowners who borrowed until they couldn’t borrow any more and are now so screwed they don’t know what to do. So, they shouldn’t be so hard on themselves.
So let’s start crunching some numbers. With yearly expenses of only $36,132 per year, they only need $36,132 x 25 = $903,300 to become FI. And since they save $38,280 per year, they’ll get there in…
| Year | Balance | Contributions | ROI (6%) | Total |
| 1 | $14,000.00 | $38,280.00 | $840.00 | $53,120.00 |
| 2 | $53,120.00 | $38,280.00 | $5,484.00 | $96,884.00 |
| 3 | $96,884.00 | $38,280.00 | $8,109.84 | $143,273.84 |
| 4 | $143,273.84 | $38,280.00 | $10,893.23 | $192,447.07 |
| 5 | $192,447.07 | $38,280.00 | $13,843.62 | $244,570.69 |
| 6 | $244,570.69 | $38,280.00 | $16,971.04 | $299,821.74 |
| 7 | $299,821.74 | $38,280.00 | $20,286.10 | $358,387.84 |
| 8 | $358,387.84 | $38,280.00 | $23,800.07 | $420,467.91 |
| 9 | $420,467.91 | $38,280.00 | $27,524.87 | $486,272.79 |
| 10 | $486,272.79 | $38,280.00 | $31,473.17 | $556,025.95 |
| 11 | $556,025.95 | $38,280.00 | $35,658.36 | $629,964.31 |
| 12 | $629,964.31 | $38,280.00 | $40,094.66 | $708,338.97 |
| 13 | $708,338.97 | $38,280.00 | $44,797.14 | $791,416.11 |
| 14 | $791,416.11 | $38,280.00 | $49,781.77 | $879,477.87 |
| 15 | $879,477.87 | $38,280.00 | $55,065.47 | $972,823.35 |
15 years!
And Here’s Where Things Get Complicated
Normally, we’d be done with this part of the analysis. The problem is, that assumes their mortgage costs are going to stay the same going forward. We know they won’t. Interest rates are going way up, with a massive 1% increase happening just last week.
So let’s figure out how to account for this. Given this new interest rate environment, when it comes time to renew their mortgage, LateStarter will need to account for this additional expense.
Unfortunately, our reader didn’t give us all the information on their mortgage that we would need, like how far they are into their current mortgage so we can predict when they’ll have to renew. So we’re going to have to reverse-engineer this information. We will be using the following mortgage calculator from Ratehub for this.
We know that their existing mortgage has a $135,000 balance, but we don’t know how far along their amortization schedule they are. And to figure that out, we need to know their starting balance.
They’ve told us their initial purchase price ($189,000), which is great, but we don’t know how much their downpayment was. Fortunately, they did give us their current mortgage’s interest rate (3.5%), and their monthly payment ($880), so if we put the information into Ratehub’s calculator and let it give us a range of possible mortgages with different downpayment options, we can simply pick the one that’s the closest.
A 10% downpayment gives us the right monthly payment, so let’s go with that. Scrolling down on the site, we can generate a mortgage payment schedule graph that shows how quickly the mortgage gets paid down. And by hovering over the different bars until we spot one with the right mortgage balance ($135,000), we can figure out what year they’re in.
Canadian mortgages typically renew in 5 year increments, so that means their next renewal is coming up at the 10 year mark. By then, the same chart shows that they’d have a remaining balance of $122,693 and 15 years left on their mortgage.
Economists are estimating that interest rates for fixed rate mortgages will settle in the 5-7% range (I think it might be even higher if inflation doesn’t start coming down soon), but to be conservative let’s go with the top end of that range and assume that worst case of 7%. By using the calculator’s renewal tab, we can figure out their monthly payment will change to…
This is a jump of 25%! That would be a pretty devastating blow to most households, but our reader made the very smart decision of not buying a house that’s too expensive. A 25% jump to their mortgage only raises their expenses by $1096 – $880 = $216 a month, or $2592 per year.
That pushes up their annual expenses to $36,132 + $2,592 = $38,724. That brings down their savings to $74,412 – $38,724 = $35,688. And their FI target also changes to $38,724 x 25 = $968,100. And also, remember that these changes only happen in year 3, which is when the mortgage should renew.
| Year | Balance | Contributions | ROI (6%) | Total |
| 1 | $14,000.00 | $38,280.00 | $840.00 | $53,120.00 |
| 2 | $53,120.00 | $38,280.00 | $5,484.00 | $96,884.00 |
| 3 | $96,884.00 | $35,688.00 | $7,954.32 | $140,526.32 |
| 4 | $140,526.32 | $35,688.00 | $10,572.86 | $186,787.18 |
| 5 | $186,787.18 | $35,688.00 | $13,348.51 | $235,823.69 |
| 6 | $235,823.69 | $35,688.00 | $16,290.70 | $287,802.39 |
| 7 | $287,802.39 | $35,688.00 | $19,409.42 | $342,899.81 |
| 8 | $342,899.81 | $35,688.00 | $22,715.27 | $401,303.08 |
| 9 | $401,303.08 | $35,688.00 | $26,219.47 | $463,210.55 |
| 10 | $463,210.55 | $35,688.00 | $29,933.91 | $528,832.46 |
| 11 | $528,832.46 | $35,688.00 | $33,871.23 | $598,391.69 |
| 12 | $598,391.69 | $35,688.00 | $38,044.78 | $672,124.47 |
| 13 | $672,124.47 | $35,688.00 | $42,468.75 | $750,281.22 |
| 14 | $750,281.22 | $35,688.00 | $47,158.15 | $833,127.37 |
| 15 | $833,127.37 | $35,688.00 | $52,128.92 | $920,944.29 |
| 16 | $920,944.29 | $35,688.00 | $57,397.94 | $1,014,030.23 |
Their time-to-retirement changes to 16 years.
That’s actually not bad. You would expect a 25% increase in housing costs would have a bigger impact, and the reason why it doesn’t is because the 25% is of a relatively small part of their monthly expenses. If they had stretched to buy a house and their mortgage was a lot bigger, this would be a very different analysis.
What if they pay off their mortgage?
But what if they pay off their mortgage faster? Would that get them to their FI number faster?
They did mention they wanted to “put in 1,400.00/month towards mortgage”. How does that affect the math?
First of all, that would decrease their savings rate. Getting their mortgage payment from its current $880 to $1400 would mean taking an additional $1400 – $880 = $520 from savings every month, or $6,240 a year. That brings their savings rate down to $38,280 – $6,240 = $32,040.
And again, their mortgage monthly payment increases in year 3 to $1096, so in order to get $1400, we need to take away $1400 – $ 1096 = $304 from savings per month, or $3,648 per year. That brings their year 3-and-onwards savings rate down to $35,688 – $3,648 = $32,040.
If they start increasing their monthly payments right now to $1400, even if interest rates rise to 7% in 3 years at renewal time, by changing around the amortization number on the renewal tab and looking for when the predicted mortgage amount cross $1400, we can estimate how much shorter their new mortgage would be, which indicates they’ll be done paying their mortgage in 10 years from when they renew.
This would speed up the time to pay off their mortgage from 17 years to only 12 years from now.
However, because they’re diverting the money they would’ve invested towards their mortgage instead, it would lengthen the time they would get to FI temporarily, until the mortgage is paid off in 12 years. Then the $1400/month can be redirected into investing and their expense would drop, thereby dropping their FI number to ($3011 – $880) x 12 x 25 = $639,300. How does that affect their time to FI?
| Year | Balance | Savings | ROI | Total |
| 1 | $14,000.00 | $32,040.00 | $840.00 | $46,880.00 |
| 2 | $46,880.00 | $32,040.00 | $2,812.80 | $81,732.80 |
| 3 | $81,732.80 | $32,040.00 | $4,903.97 | $118,676.77 |
| 4 | $118,676.77 | $32,040.00 | $7,120.61 | $157,837.37 |
| 5 | $157,837.37 | $32,040.00 | $9,470.24 | $199,347.62 |
| 6 | $199,347.62 | $32,040.00 | $11,960.86 | $243,348.47 |
| 7 | $243,348.47 | $32,040.00 | $14,600.91 | $289,989.38 |
| 8 | $289,989.38 | $32,040.00 | $17,399.36 | $339,428.74 |
| 9 | $339,428.74 | $32,040.00 | $20,365.72 | $391,834.47 |
| 10 | $391,834.47 | $32,040.00 | $23,510.07 | $447,384.54 |
| 11 | $447,384.54 | $32,040.00 | $26,843.07 | $506,267.61 |
| 12 | $506,267.61 | $32,040.00 | $30,376.06 | $568,683.67 |
| 13 | $568,683.67 | $48,840.00 | $34,121.02 | $651,644.69 |
Their new” FI target becomes relevant only after the house is paid off, so the answer is 13 years. This shortens their time to FI by 3 years.
So the short answer is: Yes. You should absolutely pay off your mortgage as fast as possible. Not only does this blunt the impact of rapidly rising interest rates, you will accelerate your time to retirement because you’ll be able to eliminate your mortgage and make Financial Independence possible sooner at the same time.
Conclusion
LateStarter may have started late, they can still come out on top even in our current rate of rapidly rising mortgages. And all because they wisely kept the amount of money they spent on their home a very reasonable $189,000. That one decision made it possible for them to throw their extra cash into their mortgage and have an impact meaningful enough to not only blunt, but counteract the corrosive effect of higher interest rates on their finances. They’ve done a fantastic job of becoming home owners without destroying their financial future. Well done!
What do you think? Should LateStarter be throwing money at their mortgage or is there something else they should do with their money?
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General rule of thumb…
If you are buying a “liability”, buy the smallest one!!!
Awesome job and a smart move! A win for LateStarter
That’s a smart rule of thumb.
The scary thing is the Canadian housing market will be in for a reckoning after 2 decades of low interest rates and hyperinflating housing prices. Then consider cyclical economies dependent on oil like Alberta. I don’t see housing prices increasing but most likely decreasing. Add to that 9 % inflation. They’ll be paying for a depreciating underwater asset .
But if you have a mortgage in Canada you have to pay it off or the repercussions are draconian.
Best advice still is to own the bank and get dividends and not work for the bank .
But these folks are stuck paying off the mortgage
It sounds like Canada is the place to move to to find affordable housing. Any homes in my state that should cost $189,000 all cost around $400,000. Due to everything that’s happening in the US on the health care front, I can see droves of Americans relocating to Canada creating more demand on the housing market. Which is something that sounds like it would increase prices, not lower them. Then, there’s the Tricon CEO Gary Berman who owns over 40,000 homes that he rents out at exorbitant rates. Since those 40,000 homes aren’t on the market to buy, he’s creating a squeeze that keeps housing costs inflated. He’s not likely to get rid of those homes any time soon so I don’t see why surrounding home prices would start depreciating.
LOL. Good luck to Americans trying to find a job in Canada that pays anything other than service job minimal wage and then good luck jumping through the years long immigration process .
I travel to Canada for work and that’s what a lot of people tell me. I heard that even though IT jobs are good, they don’t pay nearly as much as the US. That surprised me given the exorbitant price of homes in the Toronto area.
A great place to start investing in the banks is by purchasing the BMO Covered Call Banks ETF (ZWB) giving a monthly income stream amounting to an annual yield of 7%. All the BMO-Covered call funds are great including, ZWU=7.54%, ZWC=6.96%, and even the BMO Put Write fund, ZPW=8.46%! Covered Calls is a defensive strategy that performs best in volatile markets like now.
Since this couple’s incomes are within the bottom tax bracket, they will benefit the most from the dividend tax credit if their investment holdings overflow into their non-registered account (i.e. outside their TFSA and RSP). In Ontario, their taxable incomes would yield a negative tax on their dividend income. It looks to be the same in Alberta too.
Here is a video from another FIRE advocate who is interviewing the BMO Portfolio managers:
https://www.youtube.com/watch?v=vB2oDxzm-sk
Can you stop your spam please?
Dad MD, well, if they were not paying a mortgage they would be paying rent; they got to live somewhere. In any case, at least they have enough money to save and invest, like in the banks as you say.
A great place to start investing in the banks is by purchasing the BMO Covered Call Banks ETF (ZWB) giving a monthly income stream amounting to an annual yield of 7%. All the BMO-Covered call funds are great including, ZWU=7.54%, ZWC=6.96%, and even the BMO Put Write fund, ZPW=8.46%! Covered Calls is a defensive strategy that performs best in volatile markets like now.
Since this couple’s incomes are within the bottom tax bracket, they will benefit the most from the dividend tax credit if their investment holdings overflow into their non-registered account (i.e. outside their TFSA and RSP). In Ontario, their dividend income would yield a negative tax rate. It looks to be the same in Alberta too.
Here is a video from another FIRE advocate who is interviewing the BMO portfolio managers:
https://www.youtube.com/watch?v=vB2oDxzm-sk
With all that home equity they could do a cash-out HELOC/Refi and invest the cash into crypto (I’m kidding !!).
Actually, Kudos to this family. An example of the extremely rare family that buys a sensible house and lives within their means… I’m betting they’ll be FI’d long before the most optimistic scenario presented above.
FIRECracker, what would happen if they sold the house now and started renting. How would that affect the math?
I’m not suggesting they should do that, but I know you aren’t big on buying houses in Canada!
To be able to do this “optimally”…, they now need to find a similar place to rent no more than $800.00 monthly to make the numbers work to their advantage due to the “unrecoverable cost” of owning vs renting (ie Rule of 150). I have NOT done the calculations per se right down to the penny but if they can find something below this threshold to rent, I am almost pretty certain the MATH would work to their advantage longevity-wise.
ImmigrantOnFIRE
$800 per month rent?!!!! What planet are you on?
It doesn’t exist! Specially for a family of 3! 😳
Again, haven’t done the exact MATH per se but for this family to be “optimal”, the equivalent rent threshold must be under $800 per month. Hence, their decision to buy a small ($189k) “liability” makes absolute perfect sense!!!
As a home owner and a property investor myself, buying their home is definitely the correct move!!!
ImmigrantOnFIRE
Sometimes it’s not only about the optimization of the numbers between renting and buying. Owning may be part of the lifestyle they chose for themselves.
I’m confused by what happened to the property taxes and condo fees. It looks like you’re assuming they included them as part of their monthly expenses, when I was assuming that since they detailed it they did NOT include it and it’s in addition to the $880 mortgage. I can’t figure out where this extra $440 a month (property taxes plus HOA fees) is accounted for in the spreadsheet?
Income hopefully isn’t static, should that not have been taken into consideration
Assuming a static income, makes the numbers more conservative. That means they can reach FIRE even sooner unless they decide to have another child.
There are a lot of other things that can be accounted for, but it makes the illustration more complicated and maybe less reliable.
Absolutely, if you pay your house faster, it will be a big relief for the rest of your life. Personally, I think it makes FIRE easier to attain and more secure. It may take a few extra years, but it’s worth it.
Apart from this, there is a lot of complicated maths in your post, but your results are accurate. Only two variables were necessary to do the calculation : the loan balance and the difference in the interest rates. In this case, a 135 000$ mortgage with a 2% interest rate increase would imply a 2 700$ addition in interest rate charge (135 000$ X 2%). Very close to your 2 592$ result.
I wonder how much homeowners will be in trouble with the actual increase in interest rates. Certainly, a 135 000$ balance is very manageable. But, there are probably some people that are overextended. It will be interesting to see who they are.
Like Warren Buffett used to say : “it’s when the tide goes out that we learn who is swimming naked”. And now, the tide is going out for all borrowers !
Wow. I really love that paying off their loans makes them richer faster… but part of me is also thinking “why am I surprised by this?”.
Just like you always tackle the highest interest first I think you should not bother investing if the interest on your liabilities are expected to be higher than your investment gains (if we see 7% rates) on the investments. I think they should pay as much as possible and maybe even take the penalty to pay the whole thing off if the numbers work out and forget about saving anything until mortgage rates are again lower than market gains (which some claim are anywhere from 4 to 7% per year).
As an American, it blows my mind that other countries don’t have 30 year fixed mortgages. I’d be curious if this is driven by people/preferences or just policy?
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