There’s a very common reaction that happens when I talk to people or they read one of the articles here that suggests you throw 70% of your after tax income at your mortgage. People assume it can’t be done, that no one is doing it and that it’s all just a bunch of crap basically. Some will scoff at the thought of saving that much money, some will genuinely be weirded out that you’re supposed to save money as opposed to spending it all (why else would it be called “disposable income”?) and many go down the route that “it doesn’t apply to them”. Sure, YOU might be able to save that much but you have special circumstances X, Y and Z that don’t apply to me so it’ll never work!
I’ve gone over the math a number of times showing how exactly a single person can pay off their mortgage very quickly, how a couple with a child can pay off their mortgage very quickly and I plan on writing up some more various Use Cases soon as they’re some of the top most visited posts on this website (so obviously people are interested in them). So in this post I’d like to look a bit deeper into the psychology and multi-year results between someone who mutilates their mortgage and someone who doesn’t. Paying down debt isn’t just about sticking it to the banks and saving some money (although you DO save a lot), it opens up a whole host of doors and options that are otherwise unavailable. Most of this also can be done on perpetual autopilot once you’re properly setup too.
First off, there’s the most obvious thing. The monetary savings.
On the very “average” Australian loan amount of around $300,000 @ 7%, taking 25 years versus taking 6 years will save you $267,939.55 in interest. That is a monumental amount of money to most people. If you take it one step further and realise that this is money AFTER tax you in fact would actually have to earn (for an average Australian income of $70,000/year) $339,163.98 before tax.
Now, you’re not only losing this money by taking 25 years instead of 6 to pay off this mortgage but you’re also giving up the many knock on effects it has.
After you’ve paid off debt, the best thing is to begin saving up your own money and then properly invest it. You may buy shares, bonds or even a rental property, whatever it is though, it’s likely to earn you a return on your investment. If someone gave me $267,939.55 I could put it in an ING account and get around 4-4.5% p.a. on it. That’s $12,057.28 worth of extra income each year that’d I’d then be earning. If you properly invest it in a well-diversified portfolio of stock index funds, bond index funds and REIT index funds for 10+ years, you can quite likely expect an average return of anywhere between 7-10%. That’s $26,793.95 worth of extra income each year.
This is the type of earnings that you can make with the money that you DON’T give to the bank. When you pay off your loan in 6 years instead of 25, no one magically gives you $267,939.55, (although that’d be awesome!). However it does leave you with zero debt and the ability to save 70% of your income each year. And once your debts are at zero… that 70% income will start to snowball like you wouldn’t believe and along with it, will be your extra earnings each year.
A very simple calculation is to assume that a couple/person pays off his or her mortgage and then continues to save that 70% money, investing it wisely for the remaining 19 years. At the end of the 25 year period, this person would have not only a paid off house, but a further $3,439,117 in investments*.
That’s no joke. Almost $3.5 MILLION dollars.
Does that sound like a good result to you?
Freedom And Attitude
When you are debt free you are relieved of a major burden in your life. Yes, you still have to work in order to survive, but in the back of your mind at least you know you’re never going to end up on the street. You have a roof over your head and no one can take that away from you. This type of mental state will enable you to generally be more relaxed, more open to risky and possibly more lucrative possibilities plus it can take away one of the major sources of distress within a marriage – money troubles.
When you’re not worrying about debt (and instead saving hundreds of thousands of dollars) you are a happier person. Worrying about that bill that’s due or that interest rates have gone up or what losing your job might mean all go away and you can focus more on your life. Your spouse, your children, your hobbies or more specific things like travel. A mortgage is a giant elephant in most people’s lives and removing it gives you a degree of freedom that will give you a definite edge in life.
Raising Children With Ease
There are a large percentage of couples now who not only have children, but also both work. This makes thing extra complicated and costly in that the child or children have to be paid to be taken care of. With a mortgage paid off, living off of one income is quite doable allowing one of the parents to stay home and take care of the kid(s). Personally, I’d view that task as being more tedious than watching an ant construct a 10 story apartment block but to each their own! I know many people feel that children are endearing and a “must do” when it comes to life and once you own your own home, it becomes a more free, easy and enjoyable affair.
If you haven’t paid off your mortgage but still have children you can still have the option to have one parent stay home provided you hit that 70% rule. Obviously with one parent home you’d only be putting 20% of your combined incomes towards the mortgage but on the plus side you would get to spend invaluable time with your children while they grow up. This one reason alone I think should be good enough to convince many of the values of paying off a mortgage.
On top of the fact that a richer, debt free couple is going to be more relaxed and happier, is also the fact that it leads to a longer life. Not just by less stress (which has all sorts of negative effects on your body) but because what saving 70% of your income really means. To save that much income requires you to cook more of your food at home (making you eat healthier), it requires you to fix/repair/garden things yourself instead of paying someone else to do it (again making you healthier via exercise). It requires you to drink less alcohol and spend less time doing lethargic activities like shopping or sitting around in cafes. Instead you fill that time with outdoor activities, biking, walking to the train station etc once again, leading to a healthier you and a longer life.
The Growing Divergence
Whilst you may not be able to hit a 70% savings rate straight off the bat (or ever), don’t let this discourage you from always aiming for it. You may reach 60% which is still far beyond the poultry 5% most finance experts suggest. The net result is that over a 25 year period two separate couples end up with drastically different lives.
Couple A that takes 25 years to pay off a $300,000 mortgage at 7% ends up with… a house that they own. Not the worst thing.
Couple B that takes 6 years to pay off the same $300,000 mortgage at 7% ends up with the same house, fully owned. Upwards of $3,439,117 in investments. Likely a much more healthy and stable marriage due to less financial stresses. Great stability and resilience through that 25 years again, reducing stress levels. Likely they’ve spent far more time with their children (if they have them). A healthier and longer life thanks to reduced stress, more exercise and generally a more active lifestyle.
As you can see, there is a MASSIVE difference between the two lives that begins slowly for the first 6 years… but then rockets away afterwards. The end result is a family that not only owns a house, but is significantly rich to the point that they’re able to retire completely, is healthier and better in almost every way. All starting from learning how to mutilate their mortgage.
*In order to pay off a $300,000 mortgage at 7% in 6 years you require a fortnightly payment of $2,348.62. If you invest this amount fortnightly, over a 19 year period with a return of 10%, you get $3,439,117. This is the equivalent of $2,412,670 in today’s money (assuming 3% inflation) and yes, a 10% return is quite decent however even with a 7% return you’d still come away with $1,733,115. Whichever way you slice it, it’s a LOT of money!