Many would name it the biggest financial achievement of their lives: a sign of dedication and perseverance. Having a paid off house is, or at least is near, the pinnacle of their American Dream.
My physical therapist wife will tell you a story she heard while another therapist worked with one of her patients. Physical therapists often need to talk about a patient’s living conditions, so it’s not uncommon to have conversations about the patient’s house. One particular conversation went something like this:
“How long have you lived in your house?”
“Oh, well, I just paid off my house last month!”
“Oh, so you’ve been in your house for 30 years. Wow!”
Do you want your life measured by how long you’ve had debt?
We sure didn’t!
That is one of the reasons we paid off our house as quickly as we could. We took what is an enormous, immense 30-year journey for most people, and turned it into a 3 years and 7 months long journey.
Table of Contents
How did we pay off our mortgage?
1) Thinking before buying the house
The time comes when you decide that it is time to buy a house. Maybe you started bringing home a big (enough) paycheck, or you finally saved up a down payment. For whatever reason, you are ready to buy. Now is the time!
The first place most people go is online. Zillow, Redfin, whatever your favorite real estate site is. You start looking for houses and start getting ideas for what you want. Location, square footage, number of garage spaces, etc. The list goes on and on.
You begin to get an idea of what that dream house will look like.
Then you take the next step and start looking at houses with a Realtor. Perhaps you look at a few properties, or you have to look at a lot. Eventually, you come upon The One.
You say, “This is it!”
By then, it’s too late!
There is a crucial step to take before looking at houses, even just looking online. “What is that step?” you ask.
Determine how much house you can afford.
Don’t bite off more mortgage than you can chew.
Do this before looking at houses. Looking at houses is often an innocent first step, but then emotion can start to take over. House fever comes full swing and results in overspending. Spending too much on a house can cripple your finances for a very long time.
When you go to look at houses, set the search parameters such that you don’t even see houses out of your budget. Do this for other options as well, such as location and size. This will help keep you focused, keep you in your budget, and keep the feeling of being overwhelmed more subdued.
How to determine how much you can afford
Most experts and financial websites suggest that a mortgage payment can be at most between 28%-36% of your gross income. (Your paycheck before taxes are taken out.)
Examples of websites that suggest that:
The Balance
Investopedia
Another common, and conservative suggestion, is that it is less than a quarter of your gross income.
When giving these suggestions, they mean a mortgage payment with escrow. That means in addition to the money that is collected for the mortgage, the cost of insurance, property taxes and HOA dues is included.
Personally, I like to base it off of take-home pay. It gives a more realistic picture of how it will affect your personal budget.
Our mortgage payment was less than 10% of gross income.
We know that because of our Zero-based budget. Feel free to join the Gone on FIRE mailing list to get the ZBB budget helper.
Related: How to Create a Powerful Zero-Based Budget
How did we do this?
We achieved this by following the advice I just mentioned. We looked at our finances, and determined how much house we could afford. Knowing how much we could afford limited our choices for location. It meant we would have to commute, but we were okay with that for a fairly short period of our lives.
2) Thinking while buying the house
Negotiating the price
We found a house that both of us liked, and it happened to be a REO. That means it was banked owned. Banks aren’t always easy to negotiate with, but it worked out in our case. I knew I could submit a low-ball offer and not offend the sellers. We traded a few offers back and forth, and finally settled on the price.
Putting down 20% – Avoid PMI
While negotiating the price, we made sure not to offer or accept any price that would prevent us from putting a 20% down payment on the house.
We barely squeaked by on this one, as the bank accepted the highest price we could offer, without breaking this down payment rule.
Having 20% equity in the house legally prevents mortgage companies from tacking on PMI to your mortgage payment. PMI stands for Private Mortgage Insurance. PMI is insurance you are forced to buy to protect the bank in the case that you don’t pay your loan. It has absolutely no value to you.
15-Year Mortgage
Ideally, you would be able to pay cash for your house and have no loan payments. This is unrealistic for most homebuyers though, including us. Given the option between a 15-year and a 30-year, we choose the 15-year mortgage. There are two main reasons I prefer the 15-year mortgage.
1. Lower interest rates
15-year mortgages will typically have a lower interest rate. This means you pay more towards principal and less towards interest each month. Ultimately meaning you build equity in your house faster.
2. Shorter path to owning your home, mortgage free.
Pretty straight-forward, 15 years is less than 30 years. In the case that you don’t pay extra on your mortgage, having a 15-year mortgage will lock you in to getting it paid off in half the time of a 30-year.
You may be thinking that since you are paying the mortgage off in half the time, you will have double the mortgage payment each month. This is not the case, as a result of the lower interest rate.
In the case that you do make extra payments, the lower interest rate means your dollars go further.
3) Thinking after buying the house
Now comes the hard part. Paying off the house.
Well, maybe it’s not so hard if you followed my previous advice.
Given housing costs of about 25% of your take home pay, that means you have roughly 75% to pay for non-housing expenses.
Let’s say you spend your money wisely, and you’re able to save a bunch each month. I think we are a decent example of that. Our savings rate, with no mortgage, is about 60% of our take home pay. If housing costs eat up about 25% of that savings rate, that means the remainder, approximately 35%, can be put towards the mortgage principal.
In our situation, our mortgage payment was well below 25% of our take home pay. Combined with our low expenses and high savings rate, this allowed us to attack the mortgage. Most months we were able to pay at least the equivalent of 3 monthly mortgage payments, and in our best months, we were able to pay the equivalent of 10 monthly mortgage payments.
Word of advice when you’re making extra payments:
Make sure you specify that it goes toward principal.
If you don’t specify that you’re paying down the principal, some mortgage companies will assume that you are just paying ahead for next month’s payment, meaning you will pre-pay interest that you don’t even owe yet.
Before long, 3 years and 7 months long to be exact, our house was paid off. Once the house was paid for, we went back to investing all our extra cash.
What does a paid off house gain us?
Peace of mind
It’s nice to have one less money worry. We will always have a place to lay our head at night. If the markets ever turn south, and both of us are laid off our jobs, No Worries! That’s highly unlikely, but still.
No stress of paying interest
Every month that I looked at the mortgage bill stressed me out a little bit. Not because of how big the bill was, but because we were paying interest on the loan. Money that we would never see again. No mortgage means no interest, which means that stress is Gone!
I can already hear some of you thinking about losing the mortgage tax deduction.
To me, that’s not a big deal. That deduction only saves you 25% of what you paid in interest. By not having interest, I save 100%. In other words, not having a mortgage saves us 4x more than the mortgage tax deduction.
What did a paid off our house cost us?
Instead of paying off the mortgage, we could have invested the money. This is the most common argument you will hear when it comes to building equity in your house. It’s a valid argument, but greatly discounts the risk factor. The risk of a bank foreclosing on your house.
Let’s look at the math.
To simplify the compound interest calculations, let’s assume we had a lump sum right at the beginning of the 5 years we owned our house. In reality, it would be a portion contributed each month.
Hypothetically, we invested that money for 5 years and earned an above average 9% return each year. This would have netted us a 54% gain on top of our initial investment.
In terms of real numbers, let’s say that lump sum was $125,000. Invested for 5-years with a 9% Annual ROI, you would have made $67,328.
Keep in mind though, 5 years is a very short investment period, and we very well could have lost money in the stock market. Whereas investing in our house meant guaranteed lower interest payments, all the way to the point of no interest payments.
The Bonus
Our house more than doubled in value when we sold it and moved to Texas.
Our Return on Investment was 116%
That sure beats anything I could have done in the stock market. This allowed us to buy a great house only 15 – 20 minutes from our jobs.
Goodbye Commute, Hello Free time!
It’s amazing how much driving can wear you out, even if you’re just a passenger. I have so much more energy when I get home now.
The Right Decision
In retrospect, I am completely satisfied with our decision to pay off the mortgage instead of investing the money. I have no questions or regrets and can 100% say that it was the right decision for us.
If you enjoyed my story, check out some other stories from my fellow FIRE bloggers:
FIRE Away!