Frequently when you think of planning for retirement or becoming financially free in general, you think about how much money you’ll need to save in order to generate the kind of income that you’re use to. For example, how can I save $1,250,000 so that I can draw 4% and take out $50,000 each year?
In this post, we’ll look at the other side of the coin. Instead, we’ll look for a way to reduce how much income you’ll actually need while on your own. And how will we do this? By focusing in on one of your largest expenses – your mortgage.
Why Pick on Our Mortgage:
For most of us, not having to pay a mortgage anymore would save us anywhere between $500 and $1,500 per month. Say, for example, you think you’ll need 80% of our current income and that number equals $4,000. If part of our money design was to pay off our mortgage before we retire, then this may reduce our monthly income needed down to, say, $3,000. That’s a pretty significant burden to be lifted off your monthly expenses.
When you consider your other expenses, it’s unlikely that you’ll simply spend less with your credit card for food and goods, or that you’ll quit having a phone or TV. Even your car loan is a bad place to look because chances are that you’ll probably just buy another car in the next 5 to 10 years and start a payment all over again (unless you can somehow swing always paying cash).
But once your house is paid, it’s paid! And as long as you don’t move, you’ll be basically living rent free for the rest of your life without owing anyone except Uncle Sam.
Using Time to Your Advantage:
So many younger people may think that they’ve got a long ways to go before they will retire or before they’re finally ready to start an early retirement by saying goodbye to their regular jobs. But unknown to them, that’s the beauty of developing this strategy early into their money design. In essence:
• The more time you’ve got between now and your goal, the less painful it will be to put extra principal payments towards your mortgage and make it disappear altogether.
How Long Do You Have?
Let’s use a real life example: My wife will be eligible for her pension in 13 years. So let’s pretend we’re going to start an early retirement that same year.
Knowing that I’ve got to accelerate my payments so that I can finish off my mortgage in 13 years, I can use my handy Microsoft Excel spreadsheet to figure out just how much extra principal payment I’d have to send in with my regular mortgage payment to try to finish the job.
Using trial and error, I determine that I’d need to send in about $325 each month to accomplish this.
Hmmm … where could I find $325 per month (or $3,900 per year) to meet this goal? Oh yeah – my income tax refund!
Advanced Tip – Put Things In Perspective:
Remember that when you’re given the choice between paying off your mortgage and investing the money, the trick is to look at the interest rate. Paying off your mortgage early is like investing your money at the mortgage interest rate. In my example, the extra money I’d use on my mortgage would basically yield me a guaranteed 3.75% return. If you haven’t already maxed out your IRA or employer retirement plan where the average rate may be closer to an 8% return, then I’d put the money there first before you start paying extra on your mortgage.
Readers: Will you be paying off your mortgage early before retirement? If yes, is this because you want to ease the burden of how much money you’ll need, or because you simply hate debt. If not, then I’d love to know. What other major hurdles do you plan to tame before launching into retirement?