The other evening on Slope, we got into a discussion about the merits and possible ways to pay off ones home earlier than "as agreed." I thought I would do a post on this topic and go into greater detail as to the merits and some ideas for getting that done. I maintain, the average person can pay off his personal residence in less than 10 years without having to eat just beans and rice.
This post is solely about your personal residence. Where you live. Rental real estate is another area and this post does not necessarily apply to any rental properties you may have. It also is directed towards the individual that does not contemplate a move in the near or intermediate future as other factors then enter the picture.
First of all, recognize the FACT that your personal residence is NOT an asset! It is always a liability, even if it is owned free and clear of any liens or mortgages. It is ONLY an asset when you sell it and cash the escrow check. Why is that? On your personal balance sheet, any equity shows as an asset, right? Well, by my definition, to be an asset, it cannot have negative cash flow. Even a free and clear home has negative cash flow. You must pay property taxes and you should have at a very minimum, liability insurance. Fire insurance is optional once your home is mortgage free. If you cannot sleep at night without fire insurance, by all means, you will need that as well. The only possible exception to this would be if you are renting out rooms to tenants in your home.
Your home is your shelter and as soon as possible, you do not want any "bank partners" on your home. Most do not realize that if you have a 30 year amortized loan and you make each montly payment, as agreed, you will end up paying over three times the original loan balance (depending on interest rate) and it will take you approximately 23.5 years to pay that loan down by 50%! So, how can this pay-off be accelerated? There are a number of strategies.
1. When you get a 30 year fixed loan (or you have one now), get a complete print out of each month, all 360 of them, for how much of each monthly payment is interest and how much is principle. Your real estate agent should be able to get this for you. If not, I believe there are internet resources to get this information. Take that mythical $1,000 per month payment. First month say $982.00 is interest and $18 is principle. The next month, $18.04 is principle. What you do, that first month, is to take the next month's principle and add it to that first month's payment. Go to the 360th payment and strike it off! You just made that payment at the end of the loan! In other words, $18.04 today has saved you a $1,000 payment at the end of the loan! What, in effect, you have done is to create a 15 year graduated payment loan that you are in control of the payments! Many look at a 15 year amortized loan and the level payments are too high for their, then, budget. Hopefully, over time, your income will also increase.
2. Talk to your lender. See if they have a program that will allow you to make payments on the 1st and the 15th of each month, each time for 50% of the monthly payment and they then calculate principal reduction upon receipt of those payments. Some lenders can do this, most will not but it does NOT hurt to ask. Since interest is earned over each payment time period, anything you can do to reduce principle upon which interest is calculated is to your benefit. Word of caution: do NOT enroll in any mortgage reduction plan from a third party. They are charging you for something you can do without their help! Basically, such programs just adds a 13th payment per anum is all.
After doing this, then we come to a fork in the road. We need to further accelerate the pay off. There are only two ways to accomplish this. You must increase your cash flow and use that extra cash flow to pay down your mortgage and/or you must decrease your expenses and use that saving realized to pay down your mortgage.
Some starter ideas to increase your cash flow.
1. Have any spare time? Get a temporary part-time job. Even if it is only delivering newspapers in the early morning. Weekend work, etc.
2. Sell unneeded possessions. We are all "collectors" and we all have "stuff" we do not use or need. Sell them. You can even start a small home-based business doing this if your so inclined. Become expert in one field, for example, porcelain. You know what is good "stuff" and what is junk and you know what the market is in your field of expertise. Go to higher end area garage sales, estate sales, etc. Buy low and sell higher. You know what you are looking at and most sellers do not have a clue.
3. Let your creative juices flow. You may be very surprised what you can come up with when you really think about it. All extra generated cash goes towards principle loan reduction.
Some starter ideas for decreasing your expenses.
This is the area where many people balk at taking action. Most do not want to really differentiate between needs and wants. Make a game out it. You will be richly rewarded. Your free and clear home can be almost just around the corner.
1. Have an RV? How often do you use it? Would it not be cheaper to rent one for those few time you do? If so, get rid of the RV.
2. Own a car you owe money on? Lease or purchase. Think about this carefully. You need reliable transportation that is comfortable. A vehicle's purpose is to get you from point A to point B. Why would you owe any money on something that decreases in value every day you own/use it?
3. Everyone should own a "business." Have a hobby? It is no longer a hobby, it is a business. Check with your tax adviser/CPA on this. He should be able to guide you in this area as to tax consequences. If he is unwilling or unable to do this, fire him immediately and find one who will. You are missing out on important tax savings if you are NOT doing this. Tax savings is cash and goes toward principle reduction!
4. Examine every bill you have. Your phone bill. Is there a cheaper program? Do you have voice mail box? Those things cost $20+ per month. Go get an answering machine! Your gas bill. Most utilities have free programs to better weatherize your home and get that gas bill down!
5. Go out to dinner once a week? Take that down to once a month. Get some friends together and form a "dinner club." Once a week, each will, in turn, throw a dinner party! Much cheaper than a restaurant and a lot more fun!
6. Clip coupons. You can even find them on the net. Why pay total retail for the things you need? Buy in bulk for saving whenever possible. Ever asked a retailer for a discount? Try it! Times are tough! You would be surprised! Especially, if you are carrying cash! They should give you at least a small discount for using cash over a card. Costs them when you use your card! Ask for it! Worse thing that could happen is you might hear no and that does not cost a dime!
7. Start buying good condition used instead of new whenever possible and practical. Often, used will last longer than the same item bought new!
8. The use of "windfalls" which could be inheritance, job bonuses and even a tax refund. Pay down that loan!
9. The possibilities are ENDLESS! You might make a habit out of asking yourself "do I really NEED this that I am buying or do I just WANT it?" before you pull out your wallet.
Some final thoughts.
First, let's slay the dragon of "I will lose my write off of the interest if I pay my house off." Let us take a hypothetical. You own your home free and clear of a mortgage and I owe on my home. I pay $10,000 a year to the bank in interest. You pay nothing and both of us start the year with $10,000 in the bank and we are both in the 40% tax bracket. At the end of that year, I write off $10,000 effecting a $4,000 tax savings and I have NOTHING left in the bank. You write a check to the IRS for $4,000 more in tax than I had to pay. You have $6,000 left in the bank. Who is better off?
One great burden has been lifted from you if you take action now and continue to take action. Your life can change dramatically once you are debt free! All kinds of other possibilities will be open to you. Look at it as a "game." See just how fast you can get it paid off! In this game, you can ONLY win!
Get that house paid off? Throw a good old fashioned mortgage burning party! Be sure to invite all your neighbors to the bbq! Every month then, your neighbors will look at your home while THEY are writing out a check to the bank and think…that SOB!! Be sure to invite me as well. If your too far away, lift a tall cool one in my direction on the West Coast!
Yours in the constant search of the edge. In trading and in life. Market Sniper