Hindsight on Years of Aggressive Mortgage Pre-payment

I have written in depth about my mortgage and my aggressive payoff plans. I really hope that you don’t follow in my example and treat your mortgage like a pants on fire debt emergency like I did because that was a huge mistake. Keep in mind that while aggressively paying down my mortgage, I also maxed out my pre-tax 401(k), my HSA when it was available, and my Roth IRA. I also maintained a healthy six month emergency fund and another six months across liquid stock index funds and bonds.

I regret aggressively paid down a 2.5% mortgage. Over the course of 2.5 years, I made $126,000 in extra payments. At my current expense level including my required mortgage payment, that is 2.6 years of expenses. Instead of hiding $126,000 in my Vanguard taxable investment account in the form of stock index funds or in a cash savings account, I hid it in my mortgage, from which the only ways I can extract equity are by applying for a HELOC currently priced at ~4.25% in advance of when I need the funds or by selling half of the condo to my husband over time.

Doesn’t this chart look motivating? I made such huge strides on eliminating that mortgage debt pretty quickly: within the first 2.5 years, I paid off exactly 50% of the original mortgage balance.

Mortgage Balance Aggressive.png

Why did I do this?

I was scared of my mortgage.

My original mortgage balance was 3x my gross base salary when I bought the condo. I had never had debt before (no student loans or credit card debt) and having 3x my base salary in debt was HUGE.

15 year fixed mortgage rates and 5/1 ARM rates were the same when I bought my condo. A decent portion of my income came in the form of deferred compensation and I didn’t want to lock myself into the payments of a 15 year fixed rate mortgage, so I thought that a 5/1 ARM was the perfect compromise – the rate of a 15 year fixed rate mortgage with a 30 year amortization. I didn’t trust in my then-income level enough to lock in the 15 year fixed rate payments. The difference between the two payments? $1,900/month versus $1,20o0/month when the lower payment caused me to see zero increase in my annual expenses over renting and I was stashing $2,000/month into savings on top of maxing out my pre-tax 401(k) and Roth IRA.

I didn’t understand compound interest.

My parents preached that debt is bad, anyone who carries debt is financially irresponsible, and no one should hold their mortgage or student loans or any other debt any longer than minimally necessary. I’m not really certain of their investing strategy because they think the stock market is too risky and you should invest entirely in bonds, real estate, cash. That’s a debate for another time. I started saving for retirement while I was in college (back in 2007), but all of that was put into certificates, not into the stock market. No one explained compound interest to me until I found the financial blogosphere back in 2011 and despite the number of advanced math classes I took in high school and college, I never figured it out either. You don’t have to save nearly as much for retirement if you frontload it in your twenties and thirties and invest in stocks. The Vanguard S&P 500 Index Fund, for example, has an average annual return of 10.83% since its inception in late August 1976. That’s just over 40 years ago. That is pretty much unheard of in cash returns! At least in my lifetime that I can remember.

I was scared of the stock market.

Yes, I had no comprehension of compound interest, yet somehow I was perfectly happy locking away money in retirement accounts for many decades and investing in stocks there, while being scared of investing in the stock market outside of my retirement accounts. I would rather get a guaranteed 2.5% return than incur the increased risk of the stock market that could possibly get me a 10.83% return. (For the record, Vanguard currently tells me that I have seen a 9.0% return over the last 6.5 years that I’ve had accounts with them or 9.8% over the last 5 years, which is when I started hunting for a condo.) I was so scared of losing money, of seeing my account balances go down, that I took the guaranteed 2.5% return instead.

Why was this a huge mistake?

Liquidity.

I’m sitting on a desire to take a sabbatical from my highly paid tech job and I’ve spent much of 2016 setting aside additional liquid funds in order to finance that. Had I not paid down the mortgage so aggressively, I would have already had that fund. Assuming I had invested the exact same amounts I paid extra on the mortgage into Vanguard Total World Stock Index Fund on the exact same days that I made extra mortgage payments, I would have had $148,924.73 in the index fund on 10/1/2016 and I would have been ahead. Now, the stock market has done reasonably well over the past 4.5 years, so in the following chart I also compare aggressively paying down the mortgage to aggressively saving in a 1% interest earning savings account:

Investing vs Aggressive Mortgage Paydown.png

Notice how the green line and the red line are pretty much on top of each other? Cash currently would be worse than aggressively paying the mortgage by a mere 2%. Investing has been at best 19% better than aggressively paying the mortgage and at worst, $215 better, thanks to a rising stock market over the last several years. You look at this second chart and wonder why I paid the mortgage so aggressively when I could have accomplished the same net mortgage balance within $2,000 by just keeping the extra funds in cash.

What does this math show?

If I could have been convinced to not blow all of the money I threw at the mortgage over the last 4.5 years, I would have been better off leaving it in a 1% savings account than throwing it at the mortgage quite so aggressively. That would have left me with significantly more liquidity.

In late 2011, I wrote a post entitled “What to do with extra monthly and bonus cash flow?” in which I explained several ideas I was tossing around:

  1. Split the money up three ways into investments, pre-paying the mortgage, and saving for a 20% down payment on a house
  2. Split the money up 50/50 into investments and pre-paying the mortgage
  3. Split the money up 50/50 into pre-paying the mortgage and saving for a 20% down payment on a house
  4. Invest all of the money
  5. Use all of the money to pre-pay the mortgage and pay it off really quickly

My conclusion? “Right now, I prefer the first option since it still allows the extra funds to be diverted back to mortgage pre-payments or investments at any point. The fifth option isn’t very flexible and the fourth option is the riskiest.” Yet, that is not at all what I did. I went with the fifth option.

But then, once I bought a place, I picked a 5/1 ARMset out to pay it off before the rate reset, which was absolutely a side effect of the fear of the rate resetting, and got addicted to the high of paying down the mortgage. It was so much higher than any high I have ever experienced from saving. I was really convinced that the mortgage would be paid off before the rate reset, before life happened in the form of my now-husband moving ina job change that unexpectedly reduced my income, starting grad school, and getting married. I’ll talk later about how we plan to handle the mortgage going forward in our marriage.

Back in July 2012, I thought “I’m not the sort of person who would *not* take out a loan to invest. I’m the sort of person who would have more job security if I lowered my yearly fixed expenses by $14,469.48 than by having a larger amount of money in the bank.” I no longer believe that to be true and I can’t take back the large payments I made on the mortgage without doing a cash-out refinance or opening up and drawing down a HELOC. I was addicted to the fact that early on in the mortgage, I could pay $X in an extra payment, which was about Y normal monthly payments and shave off 2*Y regular monthly payments off the end. I got addicted to paying down my mortgage.

It’s all incredibly irrational. Personal finance is all so personal. But that chart doesn’t lie – I would have been better off keeping my mortgage payoff fund in cash.

Aggressively paying down my mortgage being my biggest financial mistake shows how much financial privilege I have. If you hate debt as much as I do, I am absolutely on board with paying extra on your mortgage, but not this all or nothing approach for several years like I did. That said, buying this condo is quite probably the best financial decision that I have ever made – by a stroke of luck, it has appreciated an average of 11% annually since I purchased the property. I didn’t even need to pay the mortgage any extra to get the benefit of that appreciation.

Cash could have been turned into extra mortgage payments later.

Liquidity is king.

2015 Plan B: Mega Backdoor Roth IRA

My plan has always been to pay off the mortgage after maxing out all tax-advantaged investment accounts available to me. When I first made the mortgage payoff plan, I only had access to an employee-contribution 401(k) of $18,000 and a Roth IRA of $5,500 in 2015 dollars. It is possible (I don’t know yet) that with my new employer, I’ll have access to the Mega Backdoor Roth IRA. This is where the employee contributes after-tax up to the total 401(k) annual maximum of $53,000 in 2015 and then you use in-service distribution to transfer the contributions to a Roth IRA and the earnings to a Traditional IRA (and then convert the small bit of earnings to the Roth IRA to keep things clean).

Since I don’t know whether or not I’ll have access to the Mega Backdoor Roth IRA at my new job, I made a plan for 2015 assuming I don’t and then this is my plan for if I do. I’ll go with whichever plan pans out.

The 401(k) maximum is $53,000 in 2015. The maximum employee contribution is $18,000, which I will contribute pre-tax, leaving $35,000 for my employer’s contributions and after-tax contributions. This will leave me approximately $31,425 to contribute after-tax, which is about $2,856/month averaged over 11 months or $2,618.75/month averaged over 12 months. This is clearly going to put a dent in my mortgage payoff plan, but I think it’s worthwhile.

I project my total net pay in 2015 to be $118,142.85. I also expect to have $24,000 extra in my savings account at the end of 2014, after the $5,500 for my 2015 Roth IRA.

The first $18,000 of this goes towards maxing out my 401(k). Then $34,611.43 for monthly spending plans (this includes the mortgage payment). My current plan is $550.00 to my Health Savings Account.

This leaves $88,981.42 of money to work with, including the extra savings account money. Some portion of this money will be funneled into the ESPP with a good discount, but I only see that as a cash flow annoyance since I plan to sell the ESPP funds once their holding period is up.

Next, I’ll fill up the after-tax 401(k), leaving me with another $57,556.42. I’ll throw all of that at the mortgage. I had planned on throwing $73,806.93 at it from savings in 2015, so that’s only $16,250.51 less than planned, which isn’t so bad. This would leave me with the following financial structure at the end of 2015:

  • $20,000 general savings
  • $2,800 Health Savings Account
  • $119,400 Traditional 401(k)s
  • $6,800 Roth 401(k)
  • $73,500 Roth IRA
  • $26,800 taxable investments
  • $75,500 mortgage balance
  • $659,000 net worth

I would then be able to pay about $25,746.63 extra on the mortgage in 2016 and in 2017, which should erase it save for $1,902.56, which I would take out of my $20,000 general savings account. Even if I don’t quite pay it off before the rate resets in January 2018, it will not reset high enough that I can’t afford the payment and I think that is worth it for taking advantage of the Mega Backdoor Roth IRA. I mean, an extra $30,000/year in a Roth IRA in my late twenties is too amazing of an opportunity to pass up. So then in 2018, once the mortgage is fully paid off, I’ll be able to save approximately $38,074.47 outside of tax-advantaged accounts. Note that all of these calculations also assume no raises, no appliances dying, and expenses in general not going up.

The only annoying thing about the Mega Backdoor Roth IRA is that it’ll make my checking account cash flow negative most months since gross pay – taxes – pre-tax 401(k) – ESPP – after-tax 401(k) is less than my monthly spending plan. That’s okay – I can use my signing bonus and savings account to smooth out my cash flow, plus the ESPP funds will be able to be cashed in at various intervals.

Readers, do you take advantage of a Mega Backdoor Roth IRA? How does it impact your cash flow? Would you if you had access to one?

2015 Mortgage Payoff Plan

With my current savings calculations, I’ll have about $2,788.33 leftover if I pay off my mortgage at the end of 2015. My current plan involves making the following extra payments to stay on track:

February 28th: $18,710.71 – net of my signing bonus and savings from February paychecks

March 31st, April 30th, May 31st: $1,873.21 – savings from paychecks

June 30th: $25,873.21 – emptying my savings account down to $20,000 and savings from June paychecks

July 31st, August 31st: $1,873.21 – savings from paychecks

September 30th: $11,461.73 – a small bonus and savings from September paychecks with Social Security tax done with for the year

October 31st, November 30th: $2,542.42 – savings from paychecks

December 31st: $66,906.33 – savings from December paychecks, plus the proceeds of selling all of my ESPP funds (which my honest plan is to sell them as soon as the holding period is up, but I don’t know when that’ll be so for now I’m assuming I’ll just sell them all at the end of the year), emptying my savings account, selling my Series I Savings Bonds, and my taxable investments. I’m not completely sold on the idea of selling the taxable investments since I would then end up re-buying them at a higher cost basis not long after, so it would seem a waste of paying the capital gains taxes. If I don’t sell the taxable investments, then I’ll make a $33,252.89 extra payment in December (also leaving my savings account in place) and make a few more payments early in 2016:

January 31st (2016): $1,873.21 – savings from paychecks

February 29th (2016): $6,377.71 – a small bonus and savings from paychecks

March 31st (2016): $22,182.55 from savings from paychecks and emptying my savings account would leave $321.25 remaining, which I could then just pay off since there is $1,027.32 in the budget for the required mortgage payment :)

 

This is my only real goal for 2015 financially – paying off the mortgage. We’ll see how that ends up going. I’ll make my 2015 Roth IRA contribution in February from my savings account, but I won’t worry about the 2016 contribution until 2016. I’ll also contribute the maximum to my 401(k), contribute a bit to my Health Savings Account (my employer will contribute quite a bit, so I don’t “need” to contribute that much), and contribute to my Employee Stock Purchase Plan with a good discount, which I’ll then sell later to pay down the mortgage. I’ll come up with a more specific investment plan for the year later, but this is my general plan.

Readers, what is your plan for your finances in 2015?

Can I pay my mortgage off in 2015?

I’m going to be a bit slow in setting my 2015 goals with some job stuff out in the air. Last year, I set a goal to pay off my mortgage by the end of 2015. I’ve also doubted this plan occasionally. Now that we’re a year in on that plan, how am I doing?

After making my November mortgage payment, the balance is sitting at $147,700. I will make no additional payments until I start a new job so my mortgage balance will sit at $147,000 after the regular December mortgage payment is made. That post from last November calculated that I would need to have a balance of $91,284.28 at the end of this year in order to pay the mortgage off at the end of 2015.

I still think it’s possible. Or so my spreadsheets say. I’ve been following a more irregular repayment plan the last few months than I was. My income in 2014 turned out to be a bit under my optimistic projections. I will likely end up with an unpaid break between jobs. I still don’t have an accurate picture of my 2015 savings plan. But I’m still optimistic that I can pay off my mortgage in 2015, based on my current income predictions.

My plan all along has been to empty my savings account and possibly other non-retirement investments in order to pay off the mortgage entirely. My calculations show that with the mortgage paid off, I’ll be able to save $4,500/month after maxing out my 401(k). All of my past “emergencies” have cost under that amount: my car getting broken into, needing to move on short notice, and non-emergencies such as last-minute trips. Plus, any medical issues should be covered my Health Savings Account funds. Future emergencies could include replacing any number of the 10+ year old appliances in my condo, but unless they all break at once, $4,500 should suffice to replace the dead one(s). That means that emptying my emergency fund to pay off the mortgage isn’t that scary, especially considering that I will be saving just over 2 months’ expenses each month with the mortgage gone.

I’m still going to make my 2015 Roth IRA contribution at the beginning of the year and max out my 401(k) for the year, especially since it’s looking like the mortgage will be paid off very cautiously in December if it is paid off in 2015. I’ll hold off on making my 2016 Roth IRA contribution though until the mortgage is paid off in full.

Here’s to ending 2015 with no mortgage!

Reflections on Home Ownership: 2 Years In

Woo! I have lived in my condo for over two years now. In some ways, it feels like it has been far longer (my mom was convinced I’ve been here three years). And you know what that means? The next time I request one of my credit reports, I only have to list this address :)

If I sold my condo today for the exact same amount I bought it for 2 years ago, I would have spent about $9,019.23 more than I would have renting over the same time period. If the market has truly gone up by as much as it looks like it has by the sale prices around me, buying would be cheaper than renting today by $76,284.27. Buying should be cheaper than renting at my purchase price by the end of 2014.

The mortgage balance at the end of June sat at $152,167.66. It was at $187,552.40 at the end of December, so I have paid down $35,384.74 in the last six months, for a total of $133,832.34 in the 24 months that I have owned my condo, while still maxing out my 401(k), Roth IRA, maintaining my $20,000 emergency fund, and occasionally adding to my taxable investments. I now have 57.5% in equity (assuming purchase price) and have paid off 46.8% of the original mortgage balance. If I didn’t make any more pre-payments, I would have just under 15 years left on the mortgage, which is pretty good considering that it was a 30 year mortgage 1.5 years ago.

What interesting things have I bought for my condo in the last six months?

  • ~$2,500 on the closet organizer install and painting. These have been absolutely wonderful and my only regret is that I didn’t do it right away after moving in! Spending $2,500 on it then seemed a lot harder to fathom than it did this year.
  • ~$110 on replacing the two programmable thermostats in the condo. We will see in December whether this reduced the electricity from heating at all, but the new thermostats are definitely far nicer to use and they do seem to detect the room temperature better. I’ve also been considering installing another heating vent in the master bedroom as it gets chilly on the end of the room without one in the winter. That would probably cost $500.
  • ~$140 on a new container, a second perennial and then some annuals.
  • ~$100 on replacing all of the lights in the kitchen, hallway, second bedroom, and some of the lights in the master bathroom with LEDs. If all of my light bulb electricity is in the second tier and each of these lights is on for an average of 3 hours per day, it would take 382 day to break even or slightly over a year, shaving $7-26 off each bimonthly electricity bill.

I got a bit frustrated with how much my property taxes and HOA dues went up this year ($700 from last year), but then I realized that if I was still renting, my rent would be up probably $300/month from last year, so I’m quite happy with where things are sitting at the moment.

Things haven’t been super exciting on the mortgage front these last six months. The mortgage is almost half gone though, which is pretty exciting! Some days, the chart below astonishes me at just how much of the mortgage I’ve paid off in two years. $133,832.34 is $66,916.17 per 12 months or $5,576.35 per month on average, which is a lot of money!

June 2014 Mortgage Balance

Re-thinking the mortgage payoff plan

Sometimes, I don’t feel like making big payments to the mortgage and I would rather throw the money into investments. I mean, my interest rate is only 2.5% and the balance is a lot less scary now that it is down in the $150,000 range from the $280,000 range when I bought two years ago. For now, I am going to continue with the plan of paying off the mortgage. There’s no rhyme or reason to my wanting to throw money in investments instead of at the mortgage, so it’s probably just fatigue from working on a medium-term goal. Or maybe it’s a desire to see my investments go up faster instead of seeing the mortgage go down faster. I think I’m more motivated by seeing numbers go up than numbers go down! (Hmmm, if that’s the case, perhaps I should track my equity instead of tracking the mortgage balance. Well, I do both in my own spreadsheets.)

Every once in a while, I calculate how much extra I would need to pay on the mortgage each month in order to pay it off exactly before the rate resets. As of today, that number is around $2,700 and I’m only throwing $1,800 each month at the mortgage. By the end of this year, the required number should turn into only $2,200, which might be possible. And by the time of my bonus at this time next year, it should be down to around $1,600 and the mortgage balance around $80,000. So the question at that point becomes “Would I rather take a year to pay off the mortgage and put nothing into investments in that time OR pay off the mortgage exactly before the rate resets and put everything else into investments in that time?”

I’m not going to let myself re-evaluate how much I’m throwing at the mortgage until I have reached a point where I am throwing more at the mortgage each month from my paychecks than I need to to pay off the mortgage before the rate resets, since I don’t want to rely on my bonuses. After all, my original goal WAS to pay off the mortgage before the rate resets. It just turned out to possibly be possible to pay it off months/years before that happened.

Milestone Achieved: Over $100,000 of Mortgage Paid

Today is an exciting day in my project to pay off my mortgage. I have now paid off over $100,000 of the original mortgage balance. ($102,000 to be precise.) The balance is now sitting at $184,000. It feels pretty awesome! It took me 19 months to pay off the first $100,000 of the mortgage, which averages out to just over $5,000/month.

I also finally figured out how to make extra principal payments from my paycheck in the same month! I’m almost more excited about that. I get paid on the very last business day of the month, so I don’t want to initiate the extra principal payment that day or it will debit my checking account in the following month. What I did this month was once I saw my pay statement yesterday morning (the 30th), I initiated the extra principal payment. It then credited the mortgage overnight on the 30th and debited my checking account on the morning of the 31st. Granted, it came out before my paycheck went in which might be a problem for some people, but I have a pretty good buffer in there so it worked out great! This plan will only work for the months where the last business day is not a Monday, but in that case, I can make an underestimated extra principal payment (just like I did this month since I didn’t have my spreadsheet on hand when I realized I could do this) and even it out with the regular payment mid-month. Yay!

The above might sound slightly complicated, but to me, there’s a lot more reward in sending $X to savings/investments/mortgage when I see the money appear there in the same month my paycheck does. I don’t like February’s mortgage paydown being from January’s paycheck, etc. So I’m super excited that I finally figured out a way to do that!

Happy Friday everyone!