Tuesday 20th November 2018
Recently, I spoke to a friend who had been to an event focusing on tips to help pay off your mortgage earlier.
The core of the advice was to increase both the frequency and amount of your mortgage repayments - this in turn will reduce the amount of interest paid and will allow the mortgage to be paid back sooner.
My friend asked me for my thoughts on the approach. The first thing I thought was, why would you want to worry about paying off your mortgage faster?
There is a better way and much faster way to effectively become mortgage free - and it will take a lot less time than 30 years. I am going to highlight this in more detail below.
Assuming your mortgage rate is 4% or less, you really should not be concerned about your mortgage at all. Given that inflation sits at around 3% per per year, your net interest rate is effectively less than 1% in real terms.
Secondly, it's unlikely that you’re ever going to get a loan for less than the interest on a mortgage. If you have other loans, then paying them off should definitely be the priority over making extra mortgage repayments.
Before I learnt to be an investor, I made significant extra mortgage repayments. So much so, that my loan to value on my property reached less than 50%. I decided recently that I might like to buy an investment property. I called up my bank and explained I had significant equity in my house, and I would like to take another mortgage to be used as a down payment on an investment property. The lady informed me that this wasn't possible to do in Ireland and was against the bank’s policy. She said I would need to have at least €30,000 from my own cash. My argument that I had effectively paid that already in overpayments didn't seem to matter to her!.
Even though I had voluntarily made extra repayments, I now found myself in a position where I wasn't able to use my increase in equity in a positive way when I needed to. Those extra payments were now my bank’s money and not mine. I can appreciate that policies in other countries are likely different than in Ireland, but my point is, I always thought that those extra repayments was money I could utilise in the future - it turned out it wasn’t that simple! (Update - in 2020 I was able to do an equity release by working with a mortgage broker and working with the non major banks).
I would have been better off keeping that extra money in my pocket where I could have invested it, rather than handing it over to the bank and losing control of it.
One particular podcast that comes to mind is Informed Decisions, in which Paddy Delaney interviews an American lady called Claudia Pennington. In the interview, she talked about how she downsized and overpaid her mortgage over a few years and is now mortgage free.
Her next goal was to then "look into" investing to work towards financial freedom.
The problem with this approach is that one's learning of investments will only start once the mortgage is paid off. This means you’ll miss out on years of learning opportunities to discover your ideal investment strategy. You don't learn anything paying off a mortgage. When you invest, even if just a little to start, you learn a lot about not only the investment, but also your ability to both handle and manage risk.
I have many friends who dream of the day their mortgage is paid off. They think of the freedom that will give them. However, the question I ask is, then what? What will you do with the extra income once the mortgage is paid off? Most people have no plan for what they will do once it is paid off anyway - which is why my advice is, focus on making the minimum payment on your mortgage and use any excess cash to invest. Provided you invest for cash flow, your focus can be on building up enough passive cash flow so that the cash flow can start covering your mortgage repayment.
Spoiler alert - it will take a lot less than 30 years to build up enough passive income to start covering your mortgage repayment.
Once you’re earning enough passive income to cover your mortgage repayment, then you’re going to be in the same position as someone who is mortgage free. You are effectively mortgage free!
Of course, you’re going to have one massive advantage. You see, by growing an investment portfolio that generates cash, at some point your mortgage will be fully paid off. You will no longer have a monthly mortgage repayment to make, but you will continue to receive the monthly income from your investments!
All you need to do, is find investments that are around twice as much as the interest rate on your mortgage as a minimum. So, if your interest rate on your mortgage is 4%, then if you can find a return of 8%, you’re going to put yourself in a better position in the long term. The reason I suggest finding an investment which is twice as much, is because you will need to pay tax on the profits of your investment.
Remember, your short term goal is to learn to become an investor. Even if your initial investments don’t do so well, or you're not significantly better off, the real rewards will come later. Investing is all about learning from your mistakes, so the sooner you start, the sooner you can learn from those mistakes!