I talked yesterday about what I did about my debt and why I have the attitude I have, but I didn’t talk about how to get started. Read more
The debate whether making a twice-monthly mortgage payment saves money is making the rounds on some popular blogs right now. The idea is paying your mortgage every two weeks rather than every month in order to save money. Whether this trick works depends on several things, but the most important part is that you shouldn’t pay a penny extra for this service. You should also consider twice-monthly mortgage payment alternatives.
This week, my wife and I drove to the bank and signed some papers initiating a wire transfer to our mortgage company.
Yesterday, I had the satisfaction of logging into the mortgage company’s web site, clicking on my account, and seeing the words “paid in full.”
I moved into this house in October 2002. Five years and eight months later, I own it outright. Between the house and our cars, my wife and I have paid off nearly $180,000 in debt in those five-plus years.We aren’t completely debt-free yet. We still have some student loans from my wife’s college education.
Some would argue we should have paid those before the house. I opted against it because one of the loans has a very low interest rate (lower than the house), and because the payments are small. If I walk into work tomorrow and find out I no longer have a job (that very thing happened to me not once but twice in 2005), I can easily make those student loan payments. Scraping together enough for a mortgage payment is harder.
But I’ve gotten ahead of myself. Here’s how we did it.
The debt snowball
The trick is to make your minimum payments on all debts, but pick one debt to pay off first. Then scrape together some extra money to pay it off sooner.
In my case, I started with my car. The payment was about $300. I tried to pay at least $600 on it. Sometimes I paid $900. When I got my tax refund, I paid a whole lot more than that.
By mid-2005, I owned the car outright.
By then I was also married, so we turned our attention to my wife’s car. Her payment was also about $300. So we paid $300 plus $600, the amount I’d been paying on the other car. I had a better job that summer, and we had my wife’s income too, so it wasn’t all that long before I realized we had enough surplus piled up in the bank to pay that off too. So we did.
And that left the house. The mortgage payment was around $1,000. So we paid $1,900. When we started making more money, we increased that. In recent months, I’ve been paying $3,000 on the house since I now make quite a bit more than I made in 2005.
Last month, I noticed we were very close to having enough in the bank to pay the house off while still leaving a comfortable emergency fund. I called the mortgage company to find out exactly how much we’d need to do it, and to get payoff instructions. I figured out that every month we didn’t pay the house off was costing us more than $200. So scraping was worth it.
Finding extra money
I’ve always been a tightwad (just ask my family), but in my late 20s I fell into some bad habits. I didn’t rack up debt, but I definitely wasted more money on conveniences than I needed to. I saved a lot of money the last five years or so by packing a lunch and bringing my own coffee and breakfast to work.
Do the math. I used to spend $2 on coffee and breakfast, plus $5-$6 for lunch. Call it $8/day. Figure 240 working days a year, and that’s $1,920.
I figure I whittled my daily food bill down to about $3 per day, so I saved $1,200 per year. That’s $4,800 over the course of four years. That alone allowed me to pay the house off at least nine months early.
Don’t let other people spend your money
But this is the big one. Everyone has their own ideas what kind of car you should drive, what home improvements you should be making, and other status things that really don’t matter that much.
I drive a 2002 Honda Civic with more than 100,000 miles on it. I know some people look down on that. But the car is still in nice shape, still runs like new, and has never needed anything more than routine maintenance. Plus it consistently gets 35 MPG.
If I had traded that car in after driving it for three years like the marketers say you’re supposed to, it would have slowed down the house payoff by six months. Had we done the same with my wife’s car, we could make it a year.
Frankly I’d rather have the house. In fact, if I could turn back the clock to 2003, I wouldn’t buy the same Civic I bought then. I would have been better off buying an older one that I could pay off more quickly. I could have saved an extra $4,000 or even $6,000, and we would have had everything finished a couple of months sooner.
So what about the cars now? Well, what about them? Remember, I was used to paying $3,000 a month on the house, and that obligation is gone. A year from now, there’ll be enough cash piled up in the bank to buy two cars outright if necessary. Not that I expect to need that, since Civics are famous for going 200,000 miles and beyond. The last time I went to the dealer, they told me someone had traded in a Civic with 500,000 miles on it.
As for home improvements, yes, now it’s time to do some. But why do them sooner? The boob tube tells you to do it to increase the value of the house. But why would I want to do that? So I can pay more taxes? Without me doing a thing, the paper value of this house has risen nearly $40,000 since I bought it, at least according to the county assessor. That means I paid $400 more in taxes in 2007 than I did in 2003.
Unless I was planning to move, there’d be no reason whatsoever to be concerned about property value.
On the other hand, at this point in the life of the mortgage, I was paying more than $200 per month in interest. Now that I’m not paying interest, that’s like getting $2,400 per year for free. That’s enough to finance a modest home improvement project.
But then again, if there’s something else my wife and I want that costs $2,400, we’re entirely free to go after that instead.
In what order should you pay off loans?
This is the paralyzing question for some people. Mathematically speaking, you should pay them off in order of interest. If you have a credit card balance at 19%, a car loan at 7%, a mortgage at 5%, and a student loan at 3%, then you should pay them off in that order.
I’m not enough of a math genius to run the figures, but paying them off in the worst-possible order (reverse order), generally only slows you down by a month or two.
We paid ours off somewhat less than optimally because the student loan is less paralyzing than the mortgage. The minimum payment on the student loans is about 1/5 what the mortgage payment was. When I was out of work, the mortgage was a bit of a struggle to make during a couple of those months, whereas the loans are comparable in size to a utility bill.
If nothing changes between now and then, we can have those loans wiped out in another year. If the economy tanks and I lose my job and my income drops to nearly zero, I can nurse those loans along almost indefinitely, since I have numerous options for making the $1,000 per month it would take to cover utilities, groceries, and those loans.
What about retirement?
Some people argue you should give retirement planning priority over your debts, while others say the reverse. My wife and I haven’t done much for our retirement since we got married in 2005. Frankly I can see the arguments both ways. But we’re still in our early 30s, and now we’re in position to contribute the legal limit into Roth IRAs from now until the government starts making us collect. There’s still time for both of us to pile up enough to retire.
The counter argument is that it’s foolish to invest when paying down debt gives you a guaranteed return. In this economy, given the choice between investing or paying down debt at 6 percent, what’s safer?
While there’s room for criticism if you go either way, either way is preferable to doing nothing. Unfortunately there are all too many people who have lots of debt and little or nothing saved for retirement.
This is another big one. I refinanced in 2004. I got a lower interest rate, and I switched from a 30-year mortgage to 15. The interest rate dropped, but I got nailed for a $2,000 closing cost.
I saved $500 in interest the first year, but I didn’t have the loan long enough to recoup the closing costs.
If your mortgage is the last thing you’re going to pay off and if you can drop the rate, or if refinancing will allow you to consolidate some higher-interest debt, it might make sense to do it, but factor in that closing cost. If you can pay off the mortgage in less than five years, it makes more sense to just pay it off rather than go to the expense and hassle of refinancing.
In my case, if I hadn’t refinanced, I may have owned the house a month sooner.
What about the tax deduction?
Short answer: Forget about the tax deduction. The tax deductions for mortgages are more overrated than Derek Jeter.
Let’s say you’re in the 25 percent tax bracket. I’d have to ask my accountant if such an animal exists this year, but the numbers are convenient. If I’m in the 25 percent tax bracket and I paid $1,200 in interest this calendar year, then that means in return for me paying my bank $1,200, the government is giving me back $300.
Every other time you spend $1,200 and get $300 back, it’s called losing $900.
For the past five years, I’ve been paying a lot more in interest than I ever got back as a tax refund. Eliminating the mortgage won’t completely eliminate my tax refund, but it did eliminate that interest. In effect, by paying off the house, I gave myself a $1,200 raise this year.
So there’s no sense in keeping a mortgage solely for tax purposes. If you need tax deductions, take your tax return to a good accountant. The accountant’s fee is tax deductible, and the accountant will probably find you additional deductions you didn’t think of.
If you’re in a higher or lower tax bracket, it can make a little more or a little less sense, but you’re still trading dollars for small change in any case.
There are any number of things we could have done differently. But the important thing is we now own our home and two cars outright. It’s possible that doing a few more things might have made it happen a month or two sooner. But if I’d done everything the traditional way, I wouldn’t own the house outright until age 58 (if I’d kept the original 30-year mortgage) or 44 (since I refinanced to a 15-year mortgage). Compared to 11 additional years of paying interest, what’s an extra month or two if I get a couple of details wrong?
I just returned from vacation and found the most wonderful bit of news in my inbox when I opened my e-mail at work.
From: Liza Bellis [email@example.com] To: David Farquhar
Subject: David Farquhar Special Refi for [office building where I work] Date: Friday, December 19, 2003
Attention David Farquhar
I’m Liza Bellis with a Refi-
nance and New Home Purch company.
David Farquhar, I would like to firstly help you lighten your monthly pmts for the Farquhar home at [address deleted] SAINT LOUIS, MO 63122.
use your acct 9588 and update your records with us.
Customer Service Specialist
To stop mail future: reward
This wonderful bit of news prompted me to fire off the following response, as well as to renew correspondence with a longtime solicitor.
From: David Farquhar
To: Liza Bellis [firstname.lastname@example.org] Cc:
Subject: Re: David Farquhar Special Refi for [office building where I work] Date: Monday, December 22, 2003
Dear Ms. Bellis:
Thank you for your kind offer to help me refinance the mortgage on the office building where I work. Thank you even more for tipping me off that I am indeed the rightful owner of this building. This is an asset valued at approximately $10 million that I did not even realize I had in my possession.
However, I regret to inform you that in light of this most valuable information, I have no interest in refinancing the mortgage on this office building. My financial advisor tells me it is in my best interests to sell the property as quickly as possible.
I will be contacting my realtor and I expect the property in question will soon be demolished in order to make way for a freestanding Walgreen Drug Store, as it has become that company’s practice to space its stores one half-mile apart and the nearest store is 1.6 miles away. You might wish to contact that company with a similar offer for a loan to finance the purchase of the property in question. Needless to say, I will be offering the property for significantly less than the current market value.
Your company certainly is aptly named. This valuable information secures my future so tightly as to permit my retirement effective immediately. I can only hope that this information about a pending sale will begin to repay you.
Dirty rotten filthy stinking richly yours,
David L. Farquhar
St. Louis’ newest multimillionaire
From: David Farquhar
To: Mr. Monas Nyerere [email@example.com] Cc:
Subject: Re: URGENT BUSINESS PROPOSAL
Date: Monday, December 22, 2003
Dear Mr. Nyerere:
Thank you for your kind offer for an urgent yet 100% risk-free business proposal. Unfortunately, I regret to inform you that it has just come to my attention that I am the owner of a large office building in suburban St. Louis that is worth approximately $10 million, which is about the same amount as the total money involved in your business proposal. Although your proposal is entertaining, the immediate liquidation of this office building requires my complete and undivided attention and will undoubtedly net me a larger sum of money than the 20% commission you are offering at this time.
The next time another unusually wealthy and powerful relative of yours meets with a suspicious and untimely death requiring my assistance, please do not hesitate to contact me. However, based on the numbers in e-mail I have received from you in the past, I calculate your current net worth at some $34 million. While I admire your obvious philanthropic mindset, as one millionaire to another, might I offer you some friendly advice that you retire, live off your savings, and take up residence in a safer region of the world, such as Palestine or Detroit?
Very sincerely yours,
David L. Farquhar