Throughout your life, assuming you’re not a complete screw up, your income should be going up. Whether it’s through changing jobs into a new position or moving up the chain in your current company your salary should be increasing over time especially straight out of university.
When this happens it’s obviously a very exciting time and you might go out to celebrate or even buy yourself something nice as a reward. This is all well and good, but a question you should always have an answer to is what will you be doing with this newfound wealth? Will you be squandering it… or using it wisely?
How you handle this increase in income along with the many others you’ll hopefully have over the years can be a key difference in where you end up 10 or even 20 years from now. For many the decision isn’t even considered and they simply continue spending more and more with each raise. But if you want to live life differently to everyone else and kill that mortgage in record time, you have to do things differently to everyone else too.
No Lifestyle Inflation
Lifestyle inflation can be an absolute killer. It can cause you to end up in the same exact position forty years later with all that work in between essentially going down the toilet. It’s the devil and you should be absolutely, 100% fully aware of it at all times throughout your life to ensure it doesn’t happen to you too.
The thing that makes it so deadly is that it’s so difficult to see it happening. It doesn’t happen overnight but instead slowly boils you alive like a lobster in hot water. You increase one small thing here, then another two things over there a few years later, then get that fancy new car the year after and so on. A slow inexorable march on a life sized hamster wheel going nowhere…on the plus side the gadgets are cool!
One of the key drivers of lifestyle inflation is an increased income and what you do with that money. It’s pretty difficult to inflate your lifestyle continuously for decades if you never get an increase in income. At some point you’ll be in huge debt and get cut off by the banks but with an increasing income you never get this push back.
Instead it’s like an ongoing reward that further encourages you to keep spending, to keep increasing your opulence all without bounds. With this reward comes behaviour modification that further spurs on the bad behaviour. You get a raise, you buy something new, you feel good so you do it all again. Once started this can be very difficult to wriggle out of.
Instead let’s go through the proper way to handle what happens when you get a pay rise or increase in salary for some reason. While most friends and family will instantly encourage you to “buy yourself something nice” this should be strictly avoided. If you absolutely must do or buy something to celebrate, ensure it doesn’t cost anymore than about 1% of the total raise.
For example, if you land a new job that pays you $5,000 more than your last fantastic! Let your friends and family know the good news and if you really must buy something it shouldn’t be any more than about $50. Most of the time though as said, nothing at all should be purchased.
Proper Handling Of A Raise
So what should you do with all that extra money you’re now packing away? Well if you’re on this website then there’s a good chance that you still have a mortgage (I know sucks right!). This means that you have a mortgage repayment that comes out of your pay each fortnight or so.
So just like when you manage to cut an expense by a certain amount and increase your mortgage repayment, so too should you increase it when you start getting more income.
While it initially might seem like it’s a bit boring to just put all your new income into higher mortgage repayments, it can actually generate quite a bit of excitement if you know what to focus on. Assuming you’ve already set up The Mortgage Spreadsheet you should have a specific date telling you exactly when you mortgage will be paid off.
If every time your salary increases you divert all that income towards a higher mortgage repayment, you will see this mortgage repayment date steadily go down every time this happens. It can actually be quite exciting to see your loan date get reduced significantly without having to change your lifestyle at all. It’s like a huge – free! – boost towards your goal!
Every time DW and I somehow got a pay rise we went through the same exact steps below:
- Calculate how much extra we now get in our bank accounts each pay after tax
- Increase our automatic extra mortgage repayment by that exact amount
- Act like the pay rise never happened
Probably the hardest part of the above steps is figuring out how much extra you’ll be getting paid each pay after tax. if you’re not too savvy with doing those types of calculations quite often governments have simple tax calculator on their websites that can help you.
If that doesn’t work and you’re still having troubles just wait for your next payslip. The new payslip will have your new pay amount on it and then all you have to do is subtract the old from the new to find the difference.
The Difference It Makes
While a $1,000 raise here or $5,000 raise there might not sound like it’d do any good against a multi hundred thousand dollar debt, compounding and time can make all the difference.
For example, if you have a $400,000 loan at 3.5% that you’re paying off in 10 years (this is MTM after all!) it’ll cost you $1,824 per fortnight.
If you get 3 pay raises of $5,000 each over those 10 years (say at years 1, 3 and 6) and put them all into your mortgage repayments it makes a huge difference. For simplicity sake I’m going to assume the $5,000 raises are after tax.
- Year 1: Repayments go to $2,016 and loan term reduces to 9 years
- Year 3: Repayments go to $2,208 and loan term reduces to 8 years
- Year 6: Repayments go to $2,400 and loan term reduces to 7 years
As the effect is compounding too, the entire loan would be paid off in roughly around 8 years rather than the original 10. This is also for just one salary getting pay increases. If you’re a dual income family and you’re both switching jobs or moving up the chain of command over that 10 year period and getting similar raises it reduces it to 7 years!
That’s a saving of over $23,000 in interest and 3 years of your life all just by keeping lifestyle inflation in check. You don’t have to cut back on things, you don’t have to give up anything or change a single thing. The raise comes in and you just act like nothing ever happened.
While getting a raise or new higher paying job is a fantastic and often exciting time, for most people it’s a gateway to gradual and life long lifestyle inflation. Lifestyle improvements should happen, but they need to be properly thought about, considered and weighed up not just blindly purchased.
By managing your increases in income intelligently and methodically you set your future selves up for additional and compounding prosperity. As an added bonus it takes up less time and is actually easier than the alternative for once as you’re doing nothing rather than buying new things!
The added benefits you get from stacking up your consecutive raises this way also essentially means you get two raises each time. The raise itself and the compounding benefits that result from you cramming it into your mortgage repayments which reduces your loan term and interest.
So bookmark this piece now because that way when you do get your next raise, you’ll have a step by step guide to how to handle it in the best way possible.
The benefits include: 1) How to pay off your mortgage faster than 99% of people with one hour a month of work 2) How to get rid of your debt and have the freedom to spend money on the things you love, guilt free 3) Clear outline of how to setup your expenses, mortgage and general finance 4) How offset accounts work and how to get the same result without being gouged by the big banks 5) How to cut through the crap and focus on the things that truly matter when taking down a mortgage 6) How to adjust the strategy so it works for you, even if you have kids, even if you only have one income 7) How to do all of these things and maintain a normal social life (and never be cheap).