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:
Why I Didn’t Pay Down Mortgage Debt Quicker
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 With Interest Rates
It’s been almost 10 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 have crept up. Now that mortgage rates are higher due to inflation, holding onto a bad mortgage is relatively more attractive. The reason is because my mortgage rate of 4.25% isn’t so bad now that the average 30-year fixed rate mortgage is 5.825% or so.
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? Or 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. That said, I really like investing in private real estate investments now.
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.
The Decision To Pay Down A Mortgage
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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Couldn’t you just go long on this investment property and wait until the market comes back up? I agree with many of the comments here when they say that valuations in CA are insane at the moment. I don’t think I would buy here right now until you can get a modest home for under a million. I’ve been looking for investment properties lately in different parts of the country which have higher yields.
One of the simplest ways to pay extra is to “round” up as well. Making an $1,100 payment on a $240,000 loan at 3.25% instead of a $1,044 one saves 2 years of payment and $13,000 in interest on a 30 year loan. Add in making it bi-weekely brings it down to 5 years early. In Sam’s example I’d likely add an extra $100 since $6 wouldn’t make a ton of difference. Plus that makes a nice round number moving out of my bank account monthly.
One thing that a lot of people don’t know is about the recast. Some mortgages have it written in that if you pay 10, 15, or 20% at once the bank will recast your mortgage for a new amortization schedule. In this case, you could get lower payments without a refinance which would allow you to pay down the mortgage quicker.
It’s fascinating to see that people who’ve achieved FI still find some past financial decisions painful. I like having cash on hand to invest when I see a deal, but I also am much farther away from FI. I wonder how my investing preferences will change in that time. Thanks for another great article.
Thanks for commenting Sam. That makes sense to have a plan. It’s tempting to just pay down the mortgage but you are right it would only leave us with 35k. I also didnt mention that we have a second mortgage for the house we currently live in. I think a solid plan to maybe pay off early is the way to go. We are currently getting 1900 in rent which will hopefully rise over time. Our break even is roughly 2200 at this point. I also like your idea in a different commoner about having powder dry just in case. Keep up the great blog. I read it at lunch every day while at work between my class I teach in high school.
I appreciate your ability to refinance this mortgage is limited. Would it hurt too much to take equity out of either of your other SF rentals (into a 5/1 ARM as others have suggested) or primary residence and rid yourself of the 4.25% Tahoe headache? Presumably this arbitrage would save you 1% tax-free annually – and net debt or rental income wouldn’t change.
Ripped through your Sept ’14 post “Why I’m Paying Down My Mortgage Early And Why You Should Too” as well as the post in May ’15 outlining the mortgage closing fees – yet you didn’t publicly consider the benefits of paying down the Tahoe place against paying down the mortgages of your other rentals. You’re too engaged and thoughtful in personal finance not to have considered this option at that time.
We’re aggressively paying down the mortgage on our primary residence at the moment despite an unbelievedly low rate. In the past we were slow-playing (slow-paying?) it and seriously considered taking out equity as it accumulated in the form of an auto-advancing HELOC to invest in the markets – a strategy called the Smith Manouveur that transfers non-deductible debts (a mortgage in Canada) into a tax-deductible investment loan.
Recently we’ve refocused our goals to wanting to acquire a family house in 2-3 years for when kidlets arrive and are using our existing mortgage to stash away these funds in lieu of the low returns of other conservative assets.
You bring up a good idea about taking out a home equity line of credit from one property at a cheaper rate to pay down this 4.25% mortgage. It makes paying this Lake Tahoe property mortgage off more palatable since it’s more like accounting versus bringing new money to the table to pay down debt.
For a HELOC, I think rates are around 4% – 4.5%, so it wouldn’t be worth it right now. BUT, I haven’t checked HELOC rates in a while, so let me do so now!
Smith Manouver sounds like a good move.
I don’t know, Sam. I struggle with this somewhat. I do plan to pay off our personal home mortgage just before retiring early in 2020. However, I’m on the fence about paying down the mortgages on our rental homes. Seems like a good use of “other people’s money” if you go along with the leverage side of it. Plus, if anything crazy happens from a liability perspective, the bank still “holds the bag”.
For 10 years, I’ve had the mentality of “the bank still holds the bag” when shit hits the fan for not paying down more principal sooner. But eventually, you’ve got to make a decision that you’re happy to hold on forever or you need to sell. Once you make that decision,your next decision about paying down the mortgage will be much easier.