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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.
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!