This post is dedicated to those who refuse to welch on their mortgage debt, even if they bought at the wrong time or got into a high interest rate mortgage that cannot be refinanced. I know your pain and frustration.
I’ve got a confession. I’ve been reluctant to pay down my 4.25%, 30-year fixed vacation property mortgage because it makes me face the truth that I bought a two bedroom, two bathroom vacation property at an inopportune time. Instead of attacking the bad mortgage with laser focus, I wanted to forget all about it.
I’ve been so reluctant to pay down the principal that I paid down my 3.375% rental property mortgage in 2015 instead. Illogical right? My rationale was the following:
1) I already did something positive. The vacation property mortgage was originally a 30-year fixed at 5.875%. Back in 2007, that was considered OK. In December 2012, after not turning in the keys like so many people did during the financial crisis, Bank of America contacted me for a free loan modification down to 4.25% with the same payoff schedule. It was like a reward for being good! I’m sure the Justice Department fining BoA $10B+ had something to do with it too. I had been trying to refinance the loan for years, but couldn’t because I was current. Curiously, only those who were delinquent could get some reprieve. The loan modification lowered my total payment from ~$3,200 to $2,497. Score!
2) Not 100% sure of keeping the property. My Lake Tahoe property ranks last in importance in my real estate portfolio. Most vacation properties do. If the world was going to end again, the vacation property would be first to go if I had no more money. In such an impending scenario, it would be unwise to pay down extra principal. I knew with 100% certainty that I would never foreclose or short-sale my properties in San Francisco because they are way in the money and highly cash flow positive. After such a strong recovery with much more stringent lending standards, I’m confident we will not go back to hell.
3) Investment opportunities. After the financial crisis, I felt it was time to invest more rather than pay down more debt. My net worth was rocked by ~35% and in order to get back to even or reach new heights, I felt strongly the need to put more capital to work. As a result, I’ve been investing six figures a year since 2009. I also put down $248,000 for a fixer upper in early 2014 and spent another ~$170,000 on home improvements. Only in 2015 did I decide to aggressively save cash and pay down my other rental property mortgage because I couldn’t find as many attractive investment opportunities. Besides, the 2/2 condo mortgage in SF was supposed to have been paid down by 2013.
Things Are Different Now
It’s been almost four years since Bank of America lowered my 30-year fixed rate to 4.25% and I feel like it’s time to accelerate my mortgage payment due to the following reasons:
1) Mortgage rates continue to remain low. You can now get a 30-year fixed mortgage rate for around 4.5% if you look online. Unfortunately the mortgage cannot be refinanced because the condo-hotel mortgage market never came back!
2) No feelings of regret. Before paying off my rental condo in Pacific Heights in 2015, I wasn’t quite sure how I’d feel. I was worried about tying up too much cash in an illiquid asset worth ~$1M. What if the market crashed? What if my business shut down? What if I needed a million bucks to go to Vegas and bet it on black like professional athletes?! It’s been over a year since the mortgage was paid off and I feel zero regret. Instead, I feel immense satisfaction knowing there will never be a mortgage payment again. I’m fortunate that my cash hoard has also grown to overcapacity again.
3) Lack of investment opportunities. It’s been very hard finding attractive investment opportunities with the stock market at record levels. I found an interesting S&P 500 structured note with 30% barrier protection and 150% uncapped upside participation. There are also some interesting ETFs that try to make money in an up and down market like the ETF, HTUS, Hull Tactic Fund. If someone asked me how much of my liquid assets I’d be willing to invest for a guaranteed 4.25% return, I’d say 80%. With the risk-free rate at only ~1.7%, 4.25% is a fantastic return.
4) A decision to keep the property forever. Now that it’s been almost 10 years since purchase, the Lake Tahoe property is less than 10% of my net worth. From a net worth allocation perspective, it feels more reasonable to pay it off. I’ve always dreamt of one day taking my family up there for a month to enjoy the hiking, skiing, fishing, rafting, biking, pools, hot tubs, spas, restaurants, and lake. Lake Tahoe is the perfect place for SF Bay Area residents to vacation, and The Resort At Squaw Creek is my favorite place in Lake Tahoe. I have a feeling my dream will finally come true within the next several years. Keeping the property forever is the most important reason why I’ve decided to accelerate payments.
5) A desire to always have a financial goal. I’m a finance junkie. Financial goals are extremely addicting. Without concrete financial goals I feel lost. Heck, part of the reason why I want to pay down the mortgage is so I can write this post! Creating a goal to pay down a 4.25%, 30-year mortgage early is not only fun, but a wise decision for my own balance sheet. The key is to pay it down without risking too much of my liquidity.
Paying Down The Mortgage In Chunks
Interest rate: 4.25%
Term: 30 year fixed with 20 years 6 months remaining until $0
Payment: $2,494.70 with $1,042 going to principal and $1,452 going to interest
Loan Balance Remaining: $393,233.25
Original Loan Balance: $536,000
Value Of Property: ~$550,000
Purchase Price (I’m the second buyer): $710,000
Initial Sales Price: $810,000
I thought I was getting a great deal in 2007 when I bought the property for $100,000 below where the buyers bought it in 2006. But the property value probably fell to $400,000 during the depths of the crisis! Recent comps have the property selling for anywhere between $500,000 – $600,000, which I think is not bad given the property can easily generate $70,000+ a year in gross rent.
If I do nothing but pay my mortgage, the $393,233 balance will fall to $0 in 20 years, right before my 60th birthday. That sounds a little depressing because I might not live that long. Further, paying down a mortgage by age 60 is completely uninspiring. As a result, I’ve come up with a plan to pay this sucker off by a spritely 45 years old in 2021! This way, I can die knowing my heirs will likely get a mortgage-free property.
In the past, I’ve paid down a random amount of principal whenever I felt like it. For example, on 8/12/2016 I cut a check for $2,000. A month later on 9/12/2016, I decided to go bigger and cut a $15,000 check after publishing the post, Investment Ideas At The Top Of The Market. The post made me focus on opportunity cost. Receiving a 4.25% return for 5 years (the duration of the structured note) would yield a guaranteed 23% return. Not bad for being risk free.
From now on, I’m going to be much more disciplined in my mortgage pay down approach if I’m going to achieve my goal of being vacation mortgage free by September 2021. The best way to pay off a mortgage early is to simply figure out how much extra principal to pay down a month using a mortgage calculator to get to your target date.
Given I’ve got 20 years left on my mortgage, I need to figure out how much extra I have to pay to shorten my mortgage repayment by 15 years. The answer is $5,300! $5,300 a month is totally doable based on my cash flow. Notice the $159,733 in total interest savings if I proceed with this plan.
If I want to pay down my mortgage in three years, I need to contribute $10,000 a month. $10,000 feels like a lot because I normally invest $5,000 – $20,000 a month. I’d have to start digging into my cash hoard, which starts to feel a little painful. You don’t want to feel pain paying down a bad loan because you already made a bad decision.
Initiating Mortgage Pay Down #2
Being able to generate an extra $2,497 in monthly cash flow after this mortgage is paid off is meaningful. I will certainly commit to paying off the mortgage by at least September 2021. Or, I may decide to allocate a large portion of an expiring CD in 2017 if I can’t find any better uses for the money.
The key to paying down a bad mortgage is to make it painless. You want to pay extra principal amounts with money you won’t really miss. Even paying down an extra $100 here and there towards principal will help. If it doesn’t hurt, you won’t remember the extra principal payments, but you will benefit from the accelerated payoff time frame.
Just the other day, I went to get a haircut at 11:30am but my barber told me there was a 30 minute wait. Instead of just sitting there reading magazines, I simply went to the bank to pay down some mortgage principal to kill time. I paid down a random $2,629 because I had $207,629 in savings. There’s no difference between $207,629 and $205,000 in savings. Now, I’ve only got $2,671 to pay down for the month to stay on track!
Just remember that before you decide to accelerate a mortgage pay down, especially a bad one, you must be certain that you plan to own the property forever. If not, it’s better to invest your money in more liquid investments so you have more flexibility. The last thing you want is to throw good money after a bad asset you aren’t planning to keep.
Bad Mortgage Pay Down Recap
1) Know how many years left you have until your mortgage balance goes to $0 if you make no extra payments.
2) Decide how quickly you want to pay the mortgage off within reason based off your cash flow. An easy target is choosing an age or a milestone, such as when your kids start middle school. One personal finance client chose her husband’s 45 birthday. Awesome.
3) Calculate how much extra principal is required a month on average to achieve your target. Memorize it.
4) Throw extra money towards your principal whenever you can. Every dollar counts. While waiting for a friend or going out for lunch, pay your bank a quick visit. Consider increasing your autopay so you don’t even have to think about it. Make it a fun game where you can only win if you hit your monthly target. Know that sometimes you lose, but at least you tried.
5) Write down your progress either in a word document or in an excel spreadsheet. Check your balance online each month. Remind yourself that paying down debt is a guaranteed return. Go find other people with similar financial goals to keep you motivated.
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Updated for 2019 and beyond.