Buying a home will be the biggest purchase most Australians will ever make, spending hundreds of thousands of dollars in one hit. Combine that with associated costs such as stamp duty, legal fees, insurance, moving costs, furniture and setting up the house – and this is by far the biggest financial decision for most of us. It is therefore obvious that if you want to FIRE – you need to pay off your mortgage ASAP.
You get this one decision wrong ?
It will change the course of your financial future forever. Real estate can be the biggest creator of wealth in the long term but it can also destroy your financial health if you make a big blunder.
Conventional wisdom says house prices always go up. I am a big believer in real estate but I am also a realist. Like any other asset, real estate is prone to fluctuation and can go both up and down over your investment horizon.
Just look at what happened to the Perth housing market when the commodity boom ended.
Now that housing is such a big part of most people’s wealth – it becomes incredibly important to get it right. Don’t let it become a drag on your finances. Due to the sheer size of a real estate transaction, it has a big impact on your overall finances.
DO this one thing right, pay off your mortgage quick and you will generally be OK – at least better than average. But get it wrong and you may well be working hard past your retirement age.
Don't do these if you want to pay off your mortgage sooner
Unfortunately, too many people get it wrong when buying real estate – especially if it is the house they are planning to live in. It is the most common financial mistake and also the most expensive one. Often this is due to two main reasons – the advice they receive from their mortgage brokers, bank or real estate agent and secondly their own behaviour which is many times due to peer pressure.
By the very nature of their pay structure – brokers and agents are not geared to have your best interest in mind. I am not saying they are all bad – they are just not incentivised to deliver the best financial outcome for you – the advice that will help you to pay off your mortgage. You can deal with this issue by educating yourself, doing your own research rather than blindly relying on what someone tells you and by pitching different brokers against each other to get a competitive outcome for yourself.
Secondly, don’t copy the Joneses when it comes to buying houses. Peer pressure can lead to bad decision making and this is not something you want to get it wrong. Buy what you can afford and not what your sister, brother, friend or neighbour can. You don’t know their financial and personal situation. But you know your’s so buy accordingly.
Based on my observations, this is how most people buy homes:
- Contact their brokers / banks to assess borrowing capacity. The banks provide them with the maximum amount they can borrow based on their income, expenses, savings, and the interest rate.
- Armed with the pre-approved offer letter, they set out to buy their house. At this point, their focus is on buying the house within the budget (not what they can afford but the budget that what was approved by the bank). What they can actually afford is much less. More on that later.
- They find a house that they fall in love with. After all, it will be perfect for their growing family. There is only one issue – It’s slightly above the “bank approved” budget. Wait!! It’s not really a problem because their broker can find a way around it and get them a bigger loan. Plus there is the option to pay thousands in LMI and avoid the 20% deposit.
- Eventually they end up buying a house which is 5 – 10% more than the original pre-approval amount. In their calculations, they don’t give proper consideration to other costs associated with owning a home. They might think these are not material or will take care of themselves when in fact these expenses can run into thousands of dollars each year.
- Rest of their life is spent on paying interest costs, selling the house and upgrading and repeating the process again and again.
- And as with everything in life – sometimes things don’t go as planned. Maybe a new baby arrives and the family goes back to one income. Someone gets sick or unemployed. Maybe the economy tanks.
It may or may not end badly, but the fact is most people stretch their finances. The other issue I have with this approach is that there is not much time or resources left to build any meaningful assets outside the family home. If you spend 30 years to pay off your mortgage – when are you going to invest for retirement ?
Retirement is only possible when assets outside the family home generate enough passive income. Even if your house is worth $2 million – you can’t really retire on it as you will always need a home to live in. Yes, you can downsize or go back to rent and realise some equity but that is a seperate topic for another blog. It may work but your best bet is to get the initial home buying process correct.
My method of buying and repaying homes
We bought our first home – 2 bedroom apartment some 6.5 years ago. We upgraded 2 years ago into a bigger 4 bedroom house with a decent backyard. This home was completely paid off 5-6 months back. So all in all, from start to finish we paid off our family home within 6 years (+/- couple of months). In addition, we continued to invest in other assets including 2 investment properties and a share portfolio. If we had not diverted some money to those assets we could have paid off the home even earlier.
Looking back, I think the biggest reason we were able to do it it all started with our home buying method which I am going to share with you below. I hope these tips can provide you with a different perspective and help you pay off your mortgage sooner.
1. We chose to live far from the city where prices were cheap
Both me and my wife worked in the CBD, yet we chose to travel an hour to get to work. We could have comfortably bought a place within 10-15 kms of our work place but then we would be working the next 20 years trying to pay it off. It was a trade off we made and we are very happy with our choice.
I am not going to lie. Sometimes it sucks to commute long hours but I think I would feel worse if I had to pay a mortgage for many many years to come.
2. Worked out what we could afford
There is a difference between what the bank will lend you and what you can actually afford.
The bank lends you based on your current financial situation and economic environment. I think we only borrowed like 40-50% of what the bank was willing to give us.
So how did I work out what I could afford ?
To start with I worked out what I could afford on a single income. My wife was working but we were planning to start a family. During this time my wife has taken a year of paternity leave and we have paid years of full time childcare. But this was all factored into my affordability calculations so it didn’t matter.
I factored a 2 – 2.5% increase in interest rates. We have been fortunate that this has not happened but even if it did – it was built into our numbers.
We made a budget and increased it by around 4-5 % a year plus added in childcare costs. This gave me a more realistic estimate of what my future disposable income will be like.
Finally I ensured that we still had sufficient money left after making repayments and budgeting all our expenses. All of this extra money went into making extra repayments on our home.
Let’s be clear on this. How much you spend on the house relative to your income is probably going to be the biggest factor in whether you can pay off your mortgage early or not.
3. Bought a comfortable but modest home
Our home is very comfortable, even has some basic luxuries we wanted. But we didn’t elect to have all the bells and whistles that come with a new home these days. There is no pool, only a small backyard, no freestanding stone baths and spas, and no top of the market fittings and fixtures. It not only saved us on the initial buying costs but it lowers our maintenance costs too.
4. Did not pay Loan Mortgage Insurance (LMI)
Buying a home is expensive as it is. If you add other unwanted costs such as LMI, then you are just making it harder for you. You really can’t afford a home of you haven’t saved a 20% deposit.
5. Made Extra Repayments
I started making extra payments from the first due date. I always got a kick out of it. All bonuses, tax returns, any side incomes, everything went into the mortgage.
6. We made sure we had no other personal debts
Some people comment that it was easy for me as I had a above average household income. I agree – I am fortunate to have a decent income. But I followed every single item on the list above. I overcame the urge to buy a multi-million dollar home in Sydney’s prime location. I could have – but then I would be stuck on making repayments for the rest of my life. What we did can be done on any income levels. Sometimes you just have to make bigger sacrifices then anyone else to get ahead.
There will be people who earn more than you or less than you. The goal for you is to work out what you can afford ? what you want out of your life ? and what is important to you ?
Share things you do to pay off your mortgage. Please share your thoughts in the comments below.