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Welcome back to our running series on how to deal with the biggest things holding you, our valiant Revolutionaries, back from Financial Freedom. In our third and final instalment on murdering your debt, we will be dealing with how to murder the most common type of debt for middle class households: Your Mortgage. See Part 1: Murdering Your Consumer Debt, and Part 2: Murdering Your Student Debt for the other articles we’ve written on this.
Mortgages are like assholes. Everyone has one and they all stink.
OK, not EVERYONE. There are still a weirdo minority of people who despise debt so much they’d rather save, invest, and retire in their 30’s. But for everyone else, mortgages are just a fact of life and are the biggest single expense of their working lives.
Now, our opinions on excessive mortgage debt have been covered in previous posts, but our general rule is that if you can’t kill your mortgage in 5 years, you have too much mortgage.
Why 5 years, when the typical mortgage amortization period is 25 years? Well, first of all, we don’t trust the goddamned banks. Mortgages are typically locked into fixed 5-year terms, after which point you have to renew at whatever the prevailing interest rate is, and since YOU have ZERO control over that thing, you may be forced to renew at a vastly higher mortgage rate. And with interest rates at basically zero, they don’t really have any direction to go over the next 5 years but up.
And second, we don’t trust our goddamned jobs. The average Millennial switches jobs every 4-8 years. Not because we are disloyal, lazy, and self-entitled assholes as most of the Mainstream Media seems to think, but because our jobs are so unstable we have to keep moving to avoid the axe that’s always seemingly dangling over our heads. Our employers show ZERO loyalty to us, so why should they expect any to them?
Now, our “5-year-rule” is not a rigid law (heh. Rigid.) You don’t actually have to PAY the thing off in 5 years, but you should be saving enough money outside of your normal mortgage payments to be able to pay it off when the 5-year term renews if you so choose. That way when the bank goes “psyche! Double your payments!” You can go “Nope. Fuck you.” and throw your wad of saved cash in the face, killing off your mortgage in one fell swoop and hopefully making the banker drop his monocle into teacup.
So how do we do this? Well glad you asked.
Rule #1: Increase Your Debt-Killing Ammo
This should be the first thing you do because it’s the least complicated and least risky. To figure out how much ammo you have, simply take your take-home after-tax pay (combined if you’re married). Now minus off your basic living expenses (food, gas, etc.).
So for example, if you make $3000 a month and you spend $2000 on basic necessities, you have Debt-Killing Ammo of $1000. This is how many bullets you can shoot at your debt each and every month. What you want to do is figure out how much ammo you’ll need to kill your mortgage balance by the end of your 5-year term.
To do this, go into a mortgage calculator like the one we like to use at www.canadamortgage.com and type your mortgage details in. Then set the amortization from 25 years to 5. This is how much you’d have to pay in each month to be able to kill your mortgage in 5 years instead of 25. So for a mortgage of $150,000 @ 4%, this is what the 5-year-murder-plan looks like.
That mortgage payment of $2760 is what you need to be saving in order to kill your mortgage. If you can hit that, or come somewhat close (if you take 7 years instead of 5, no biggie), then you will never be a bitch to your mortgage. Instead, it will be your bitch. You can use that money to pay off your mortgage in extra payments each month, or you can wait until the end and dangle a giant mortgage-killing axe over its head, threatening to chop its head off if it doesn’t behave.
So to increase your Debt-Killing Ammo, you have two options: Increase your Income or Reduce Your Expenses.
A few things you can try:
- Take on extra shifts at work. If you can get overtime by working during the holidays, do it!
- Kick ass at work and got for that extra promotion. With greater responsibility comes greater pay.
- Take on an extra job. Here’s a story of a guy who worked three jobs to pay off his mortgage in his 30’s. If he can do it so can you.
- Take part in the Sharing Economy. If you have an extra room, rent it out on AirBnb. If you have time on the weekends, drive for Uber. It’s only temporary, and you may find yourself actually enjoying it like Financial Samurai did.
Rule #2: Refinance Your Loan
So let’s say you tried that and you’re still coming up short. The next step is to monkey around with your mortgage.
This can get a little tricky because a mortgage is unlike most other types of debt where the lender generally WANTS you to pay them back. Instead, when you pay back your mortgage too quickly, the lender gets mad. You see, they were counting on you to continue paying your interest like a bitch so they can continue to make money for many many years, so if you break your mortgage for whatever reason, they lose money. As a result, many mortgages have penalties you have to pay if you attempt to refinance your mortgage to take advantage of lower interest rates before its term is up. Each mortgage is different. Commonly in Canada, it’s 3 months worth of interest payments. In the USA, it’s 6 months worth of interest payments.
But the worst prepayment penalties that get slipped into mortgage documents is what’s known as the Interest Rate Differential, or IRD. Here’s how it works.
To calculate the IRD, the lender takes the old interest rate, minuses off the new interest rate, then multiplies that amount by the time remaining in your mortgage term.
Let’s use an example to see how this works in real life. Say you have a mortgage of $500,000, taken out at an interest rate of 6%. Standard 5 year term, standard 25 year amortization. Here’s what your first term’s payments look like.
Now let’s say 2 years in, mortgage rates drop. You can now get one for 4%. Great, you think! You can lower your mortgage payments! Since you’ve dutifully paid your mortgage for 2 years, your mortgage looks like this.
You take your outstanding balance of $481,455 and roll it into a new mortgage for the remaining 3 years of your 5 year term. Because your interest rate is now lower, your mortgage payments drop and the end of your original 5 year term now looks like this.
Under the original 6% mortgage, you would have paid $141,126 in interest. But because you were so smart and refinanced, your actual interest paid is now $58,232 (original 2 years) + $54,983 (last 3 years) = $113,215! You’ve saved $27,911! You’re a genius!
But THEN the IRD kicks in. When it comes time to file the paperwork, your original bank says “Hold it!” and assess you a penalty for breaking your mortgage. The IRD is calculated like so:
(6% – 4%) x $481,455 (outstanding mortgage balance) x 3 (years left on term) = $28,887.30.
So now by refinancing to a lower interest rate you’ve actually paid MORE money somehow!
See how sneaky that is? And since most people don’t read half the contract they sign when they get a mortgage, the bank is able to sneak crap like this in and then SURPRISE, you’re screwed when you try to refinance.
So go dig out your old mortgage contract and see if there’s anything like that in it. If not, refinancing might help you. But if it’s in there and you accidentally signed it without understanding it, you are shit-outta-luck.
See why we don’t trust banks?
Rule #3: Sell Your House
Fortunately, unlike most types of debt, mortgages are attached to something with value, a.k.a your house. So worst case scenario, if you’ve accidentally bought WAY too much house and have inadvertently put yourself in decades of hock, you can sell your house and undo it. That is, assuming the housing market hasn’t crashed and there’s someone willing to buy your house. And sure, you’ll end up paying ridiculous fees (like 5% to the real estate agent for putting up a few signs), but this is an option if you’ve found yourself deep in a hole before you found our weird little site.
Rule #4: Declare Bankruptcy
Generally, this doesn’t make sense for most people, as the bankruptcy trustee will simply sell your house to cover your debt for you. However, if your house rapidly decreases in value and you find yourself owing more in your mortgage than your house is actually worth, bankruptcy may be an option. Thousands of Americans were forced to go through this in the housing crash of 2008/2009, and unfortunately idiots on this side of the border who went nuts with their borrowing in Vancouver or Toronto will go through this too. No one knows exactly when, but nothing goes up forever.
If you find yourself in this situation (known in finance lingo as the delightful term of being “underwater”), consult a bankruptcy attorney. Then bend over and kiss your credit rating goodbye.
That’s it!
Phew! As a early retiree who’s never been in debt in our lives, we didn’t expect to be spending so much time talking about debt, but you, the Revolutionaries, asked us to, so we listened.
And as always, we love to hear from you! Are you currently struggling with crushing mortgage debt? Did you find some creative way of getting out of it that we didn’t cover? Tell us your story in the comments below!
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The mortgage thing is something that our household isn’t quite sure what to do with. Student loans are our first priority. We don’t like that the loan isn’t tied to something (i.e. if we really hate the loans, we can’t sell anything to get rid of it). I crushed my student loans already, but the significant other will have to crush hers next.
Then we’ve got a house (really, its her house). We pull in some income from it by Airbnbing out a room, which is really fun, not all that weird once you get used to it, and so much better than getting a roommate. At some point in the future though, we’re going to have a lot of excess cash, and then we’ll be in a position of wondering, do we invest it or pay down the mortgage?
I could see one scenario where we pay down the mortgage in a few years, rent out the house, and then basically use our rental income to pay for much of our living expenses. Probably hire a property manager or something to deal with the day-to-day.
Another scenario, is to invest all the extra money and then reassess at some point in the future if we want to use that money to pay down the mortgage in one fell swoop.
Obviously, this is too far out in the future for me to really make any good decisions yet though. Mortgage debt is good debt, right? haha.
When I say murdering your mortgage, you don’t actually HAVE to pay it all off. It the terms of the loan are favourable, you can leave it. But you can “cover” the loan, ie have enough money saved up so you could kill the loan at any time, but not actually pull the trigger.
In a case like yours where you’re planning on turning it into a rental property, it may make sense to actually NOT pay it off. We’ll discuss this in a future post.
The IRD can be even WORSE than you have described. The differential is not necessarily based on the rate of your mortgage. Most banks in Canada base the difference on the POSTED rate at the time you took your mortgage out!!! So for example, if the posted rate was 4.95% and you got your mortgage at 2.95% and are trying to refinance at say, 2%, then the differential is usually calculated as (4.95% – 2%) x 3 months minimum. The banks LOVE to ream you on the IRD. Be VERY careful here! The moral of the story is to ALWAYS read the entire mortgage document before you sign and to understand the terms. You may not always be able to negotiate, but you have nothing to lose by trying…IF, you know what you are negotiating for…
Tell me about it. Like I said, modern day bandits dress in thousand dollar suits and rob you by tricking you into signing shit you don’t understand.
This is a very timely article for me, as I just paid off my mortgage this morning! At the end of the day it took 6 1/2 years to payoff (just outside of the 5-year window), of which the last 3 years I became serious about it and paid the remaining 95% of the principal off.
I agree with everything you’ve written and suggested, especially where you say, “…you should be saving enough money outside of your normal mortgage payments to be able to pay it off when the 5-year term renews if you so choose”. This was exactly what I did by paying it off in one big chunk as compared to making extra monthly mortgage payments. This was just in case of an emergency, or if I decided to change my mind and not hold onto the home. I can venture a guess which way you would have gone, but I digress 🙂
Another thing I did was take on a side hustle the last 2 years to boost up my debt-killing ammo. This really helped big time and there’s no way I would by typing this right now if I had not made this decision, even though I still get a ton of slack from friends and family.
To those that currently do have a mortgage, I’ve got to say it’s an incredible feeling when you see “Outstanding Principal Balance: PAID IN FULL” next to your name.
I can imagine. Good for you and congrats on your new mortgage-free life. Did you throw a mortgage burning party?
Thanks Wanderer! Unlike Sean Cooper, my situation is way less deserving of a mortgage burning party than his. I didn’t have nearly the same sized mortgage and home that Sean has (although we both live in high COL areas), no renters living inside my home, and only two jobs compared to his three.
I was thinking a small pizza party. Maybe a pizza/mortgage burning party? That could be a good idea!
Thanks for the mention. Dude, you gotta go all out. Even if you just order pizza, at least call it a mortgage burning party. We need to make this trendy! haha
Thanks Sean for the comment! Loved your story when it came out last year (the suit was a nice touch while burning your mortgage papers btw). Anyway, you know what, now that you said it…you’ve convinced me to have a mortgage burning party. I agree that we do need to make this into a thing 🙂
Or, you know…instead of paying off a 3.5% mortgage you could invest those funds at 7% and earn more than you’d save by paying off the silly mortgage.
Another way to think about this is….a 3.5% mortgage after inflation is really only 0.5%. If we want to get *really* fancy-shmancy we should actually compare the mortgage rate to average rental growth rates in that area.
But all this is probably be included in the “advanced class”. 😉
Yes definitely a more advanced topic. I do know some people who have pulled this off (FrugalTrader from http://www.milliondollarjourney.com comes to mind), but I wouldn’t recommend this to most people because you can REALLY screw yourself over doing this.
Mortgage can be both your friend an enemy. The way we are doing it is in the first year we’ve worked our mortgage down to a lower risk category (based on the outstanding mortgage per property value ratio) in order to reduce the interest by 0.5%. This is done free of charge, you just need to notify the bank that “Hey guys, I’ve been a good boy”! Seems like it’s not something you have in Canada.
Also in the Netherlands 10 year fixed interest rate is only a little bit more expensive than 5 years one. So if a bit of inflation finally kicks in, it’s a winning situation.
Actually we are planning to INCREASE our mortgage within a year in order to invest in a rental property. Getting a loan for about 2% and invest in something that brings 5-6% is a really good deal.
Of course sometimes mortgage can be a real pain in the as* and one thing I very strongly agree with: if you don’t use your bullets to murder it, invest them, so you can say bye to the mortgage in case the situation requests so.
Actually what you’re doing is one of the few situations where it makes sense to NOT pay down your mortgage. I may write a future post about this…
The best thing that I ever did was pay off my mortgage. It took me slightly longer at 7.5 years but it’s GONE. It is the best feeling ever not making that monthly mortgage payment. I get the math of some people saying I could invest in the stock market and make more. I actually calculated the difference between the two after I paid off the mortgage. 0.2% difference between the mortgage rate and S&P 500. Well worth the loss of 0.2% 🙂
As always, it depends on the conditions. Based on that you paid it off in 7.5 years, you bought your house in 2009 or earlier (as the difference was 0.2%, I believe earlier), so I assume you had a mortgage rate of at least 5%. Considering this, I think you made a wise choice to get rid of it as every payment you made resulted in a fixed 5+% return.
My above comment relates to situations like we have nowadays. Having fixed 10 years mortgage with interest rates around 2% is quite favourable. It’s very likely that you can find investments that return more on a 10 yr basis.
Awesome! Congrats! I actually don’t like the idea of keeping your mortgage and investing instead because a sudden interest rate hike (or whatever) may force you to sell your portfolio at a loss to raise cash. Regardless you’re doing fantastic. Good work!
Odd post considering your main preaching is to not own real estate in the first place – so obviously you speak from a position which you have never been exposed to – very odd or are you blowing smoke?
ps. We (wife and myself) paid off our mortgage, murder is illegal in most jurisdictions, in a little over 2 years – second best personal finance move ever; first was buying the real estate (house) in the first place
pps. bought the house after travelling around the world for 2 years and no we did not have an inheritance – we worked for it
It’s because people asked me to write about debt as it was the #1 thing holding them back.
Not a very attentive reader are you?
Interested to know why you are reading this blog?
Fortunate enough to have had parents that taught me not to waste money so now I have no mortgage and never have had one.
As a person who has never taken on any debt, I strongly object to the ‘weirdo’ classification…in the same way a gun-toting vigilante would call the peace-loving gun-shy population weirdos. ? Yes, we are rare beings who hover in weirdo sites like yours looking for likeminded weirdos.
Embrace your weirdness. You were born this way! *sings Lady Gaga*
As an asset, a house or even a townhouse can generate income, but things have changed.
In Canada T2 and company have changed the rules, now you have to declare that you don’t have a rental suite, or rent out a portion of your home, else you cannot claim the capital gains exemption. But it doesn’t cover renting a room.
I live in a city that has a .6 rental vacancy rate… omg, there is no place for students to live? consider opening your space to a student, easy rental, as the University, College, and SD’s all have coordinators that take care of everything.
We have done this for years, I currently pay an extra 20% on top of my Mortgage, as i want that sucker gone when I retire and travel Asia.
cheers
Yes, kill that mortgage! And we can attest to the awesomeness of travelling in Asia. If you stay in the southern parts, you’ll never have to see a snowflake again and the prices are insanely low. As much as I loved Europe, I’d much rather live in Asia long term.
As always, its a balance. Invest at 7% or pay off Mortgage at 3%. Think of your mortgage as your bond fund, or as diversification. No, it doesn’t matter how much you pay off, as long as you can make the payments, but its 3% compounded that you pay to someone else. Its a constant return for the lender. Do you have any investments that Guarantee a compound 3% return, with no principle loss ? Yes you do, saving the interest or making interest, amounts to the same in my book.
Also you protect yourself from mortgage rate increase, further saving money, rates just went up across the board, and will continue. I will renegotiate this year, and hopefully lock into a lower rate, but pay the same. I have increased payments twice, as per my options, and can still make lump sums, but need money elsewhere, (RESP, and RRSP) this way I am still increasing investment capital, and take advantage of a Balanced Portfolio, at approx 6-8%, but save 3-4% in future mortgage interest.
Balance is the key, not all your egg’s in one basket. You have a paid off house and no investments? One Egg, Once Basket… big omelette…
FC, your awesome… ok Wanderer too…
cheers
D.
Una pregunta, si tengo deudas debo destinar todo el dinero que pueda ahorrar y utilizarlo para pagar la deuda o debo tener un equilibrio entre tomar una parte para pagar la deuda y ahorrar otra parte?