If you’re thinking about paying down your mortgage, start with the basics. First pay off any very high-interest debt, like credit cards. For everything else, I like using the cash flow index method to choose what to tackle next. If you want to know how we paid off our mortgage in five years or less, keep reading.
Because mortgage payments are spread over 30 years, a mortgage often ends up low on the priority list. Once your urgent debts are handled, though, you might decide to aim for a fast payoff.
I’ll admit I bent the cash flow rules a bit with our situation. We still had a big chunk of student loans from my wife’s graduate school, but the rate was only about 2%—roughly the rate of inflation—so it didn’t make sense to pay more than the minimum. Those payments were only about a quarter of our mortgage payment, so they didn’t hit cash flow too hard. We planned to revisit that loan later, when pay and priorities changed.
Plenty of smart people will tell you that paying off a mortgage early isn’t the best financial move. But for us, being mortgage-free meant one less financial cloud hanging over our heads. That peace of mind is hard to measure.
There are rational reasons too. Paying down a mortgage is like a guaranteed return equal to your mortgage rate—say 4%—because each dollar you reduce is money you won’t pay interest on. Long-term, that can save tens or even hundreds of thousands in interest.
To escape the cubicle, I needed to cut or eliminate needless monthly bills. Getting rid of the mortgage freed about $800 a month for us. After payoff we ended up recouping $745 each month—almost enough to cover groceries.
We got aggressive about extra mortgage payments starting in early 2016 with a goal to finish by January 2019. We nearly hit that target, but it took another six months to pay the last penny.
Choosing a 5/1 ARM when we refinanced in 2015 helped a lot. Having a soft deadline—February 2020, when the ARM could reset—gave us the push to finish. ARM financing can be risky; it was a major factor in the 2008 crisis. What can happen is simple: your rate starts low and payments are manageable, then when the fixed period ends the rate and payments can spike. Not fun.
We knew the risks when we signed with Wells Fargo in 2015. I’d read a tactic from Mr. Money Mustache: refinance at a very low rate, then attack the principal aggressively. A lower rate increases how much of each payment goes to principal, speeding up payoff.
Refinancing to a 5/1 ARM gave us five years to finish. Rates were very low then—we locked in at 2.625%—and that made a big difference in chipping away at principal.
A bit of background: we bought the house in 2004 for $245,000. Back then I didn’t have much saved, so I used a HELOC to create a large enough down payment and avoid mortgage insurance. My net worth was effectively zero.
If you want to avoid PMI, a “piggyback” loan or HELOC can help you hit the 20% equity mark. PMI can add anywhere from about $100 to $300 a month, and it’s a sunk cost if you can avoid it.
Using a HELOC helped avoid PMI, but it also slowed progress on the mortgage for years. After I repaid the HELOC balance, I later used it to pay off a car loan and then to help put down payments on rental properties. It used to be a common way to move debt around and get some tax benefits.
By 2015, after owning the house 11 years, I’d only barely dented the mortgage principal. That’s what happens when you drift along on a 30-year fixed mortgage: in the first decade you pay mostly interest. On a $220,500 mortgage (that’s $245,000 minus a 10% down payment), a 30-year schedule can show over $255,000 in interest paid over the life of the loan. Wild when you consider the house cost $245,000.
When we started the payoff project in late 2015, the balance was around $190,000. After the low-rate ARM kicked in, we mostly made minimum payments while I focused on higher-interest student loans first. By July 2017 the balance was $177,000, and the lower rate was already helping. That’s when we switched to full-on aggression: every extra dollar each month went toward the mortgage.
By July 2018 the balance was down to $91,000. Seeing five digits instead of six on the fridge whiteboard felt great, but I wasn’t satisfied until it showed zero.
There are opportunity costs to consider. You could invest extra cash in the stock market, which has done very well in recent years, or put money into rental properties where returns can be higher. In 2018 we hit a detour: an Airbnb project that required a $25,000 down payment plus roughly $15,000 in setup and refurbishing. Without that, our mortgage balance would be closer to $50,000 instead of where it was.
Even with the Airbnb detour, we were still on track to pay off the mortgage before our 5/1 ARM reset in February 2020. That mattered because rates could jump to 4% or even higher after that. The principal we paid down during the low-rate period more than offset potential future rate rises. For more on how ARMs can sometimes beat 30-year fixed mortgages, read Financial Samurai—but go in eyes wide open.
Part of our financial plan is removing things that block freedom and choices. If you’ve owned a house, you understand the stress of a mortgage. Research on whether to pay off a mortgage early is mixed—many smart articles contradict each other—so there’s no single right answer. That ambiguity makes the decision especially tricky for people chasing Financial Independence.
Another real risk to consider: foreclosure. No matter how much principal you’ve paid, the bank can foreclose if you miss payments. If you lose your job or face a disaster and can’t make payments, all that work paying down the mortgage could be for nothing. The bank owns your home until the loan is fully paid—so foreclosure is a real, scary risk.
Common advice is to invest extra money in the stock market instead of paying down the mortgage, aiming for long-term returns that might be around 9%—and then possibly buy rental properties for even higher returns. Why not then keep the mortgage and pocket the spread between your mortgage rate (say 4%) and market returns? That can make sense, especially with mortgage interest tax deductions factored in. But you lose that deduction if you fully pay off the loan.
Nobody can predict future market swings. If retirement is near and cash flow matters, you may not want to rely on the market. If you have 20 or 30 years until retirement, investing in the market is a strong choice.
What about renting instead of owning? I respect that view—many in the early retirement community prefer renting. For me, I enjoy owning a house I can customize and work on. Owning also protects you from rent hikes and the landlord choosing to sell—issues that can force you to move, even with a lease. If you live in an extremely expensive market like San Francisco, L.A., or NYC, though, renting or relocating can be the smarter move.
So, what do you think? Now that you know how we paid off our mortgage in five years, would you try it?
Postscript 7/3/19: We paid off the mortgage early in May 2019. No champagne—just a clean whiteboard on the fridge and one less cloud over our heads. Whew.