If you want to greatly reduce your mortgage payback period you must increase the size of your repayments, there is simply no way around the math. I’ve previously discussed some ways that you can decrease housing, food and transportation costs to allow you to put more money into your mortgage. However, at the end of the day how far you go with increasing your savings rate in order to pay off your mortgage faster is going to come down to the economic concept of opportunity cost; which is essentially asking the question “what use for the money did you forgo by putting the money into your mortgage?”
The question I want to explore in this article is what effect does putting an extra $200 per month (~$50 per week) have on a mortgage’s payback time? In order to do this I created a spreadsheet to look at payback periods for mortgages between $200,000 and $600,000 at $100,000 increments. I used an interest rate of 3.08% which has been referenced from ING and calculated for repayments made monthly.
Here are the results:
Immediately what stands out to me is that at the lower end of mortgage repayments there is a huge benefit in increasing payments by $200 per month (less than $50 per week). For example going from $2000, to $2200 monthly repayments on a $400,000 loan cuts the repayment time down by 3 years. To put this in perspective if you were to swap a few restaurant work lunches each week for some home cooked meals you’d easily be able to pocket $50 a week.
The size of the incremental benefit does decrease steadily as the repayment amounts increase though; looking at the $400,000 loan value going from $4400 to $4600 per month only decreases the term by 5 months. This fact leads me to my personal experience of having times when I was overly focused on accelerating our mortgage repayment rate to the point where I had trouble using money to enjoy the present. What I’ve learned from this is that sometimes a little balance is nice.
So if you’re considering paying off your mortgage faster this table should help you to consider the value of paying your mortgage off x months faster vs the opportunity cost of spending that money for enjoyment now. I’m of the belief that the most effective way to increase your savings rate is to remove as much spending as possible that does not bring you happiness or contribute to improving the quality of your life. Cutting spending in this manner essentially eliminates the opportunity cost of the money going into your mortgage makes it a very sustainable way to approach this challenge.
One final comment that I’d like to make is that at the time of writing interest rates are at all-time lows in Australia which amplifies the effect of making additional repayments – low interest rates mean that you’re paying down more principal. So if you’re looking to reduce your debt now is a great time to do it. For those of you looking to get a mortgage then I’d say that you should look at recalculating pay back periods using a few scenarios with using higher interest rates to allow yourself a cash flow buffer.
Engineer your freedom
References
ING, 2019, ING Home loan interest rates, viewed 2/11/2019, <https://www.ing.com.au/rates-and-fees/home-loan-rates.html>