DISCLAIMER: I’m not a financial adviser, and I’m not a licensed fiduciary for any bank or investment firm. I’m just a Software Engineer who is currently looking to pay down his debt before this whole country burns down. I’m just a guy who hates debt, HATES debt; I don’t even like to have what most financial advisers would call “good debt” like a home mortgage. Frankly, any debt is “bad debt” if you ask me. Now with that said, let’s begin…
Do you “own” a home? Why the quote fingers? Let’s face it; owning a home doesn’t feel much like ownership when you have 30 years of indentured servitude to a mortgage lender. My interpretation of ownership means that it’s mine; not a banks’ who is letting me live in their investment and keep their lawn mowed – mine alone. I’m putting together a plan to pay off my house as quickly as possible and I want to fill you in on my plan. I’m hoping that you too can use this plan to buy the keys to your shackles and free yourself from the debt of home “ownership” and become a home owner.
This plan is simple, but first we need to check off the obvious questions:
- Do you own a home or plan to buy a home?
- Is your loan:home ratio at least 8:10 (80% of the value of your home?)
- Do you have a job that is relatively stable? ex: salary, or self-employed with stable clients
- Most importantly, are you a saver? Spenders are sure to fail here so re-evaluate your life and ask yourself if home ownership is right for you.
- Do you plan to live in this home for at least 3 (preferably 10) years?
Okay, if you’ve checked all of these boxes you are probably okay so far… There’s a little wiggle room in these answers; no job is truly “stable” and some banks will loan upto 100% loan:home ratio.
I’m going to use rough numbers because I don’t know what you make for a living, but I do know the median household income for most states seems to be around $60,000. The reality of our country is most individuals are closer to $50,000 than we would like to admit and so I’m going to run some numbers and see what that person can afford.
Local state and property taxes are different from state to state so I’ll let you nudge these numbers to fit your own needs. Here are my conservative estimates that I’m working from:
Gross Income (GI): $50,000
Net Income (NI): GI * 60% = $30k (approximate, after social security, medicare, medicaid, benefits, state/local taxes)
Mortgage Funds (MF): NI / 52 = ~$575
Here I’m defining MF to be the amount of money you can spend on a mortgage (or rent) and still be able to put some money into savings each month, after other expenses like food or gas or keeping the lights on and toilets flushing. Remember, saving is key here. Why 52? This is no scientific number but let me paint you a simpler picture. Imagine that you have a fixed amount of dollars you can spend each month. In a perfect world you’d want to spend about 1/4 on your mortgage or rent, and absolutely no more than 1/2 on cost of living (food, clothes, commute, bills, etc); leaving about 1/4 of your monthly expense going into savings for the day your car breaks down or your roof leaks or you drop a bowling ball on your foot – who knows, life is crazy. There are roughly 4.3 weeks in a month, or 52 weeks in a year and we are trying to keep the mortgage under that because the key to this working is your ability to save.
To make the numbers simple let’s say we are looking at a house that is around $100,000. I realize that is not a very luxurious home, but if you are making $50,000 I sure hope you aren’t shopping for some 3,000 square foot Mc-Mansion. We are looking for a home we can pay off quickly, so the home is working for us instead of us working for our home. Again, the total home value depends on your own local state and property taxes so don’t take my numbers as gospel; only an example.
Here’s the hard part… If you say that you are a saver I’m going to assume that you either have 20% to put down on the purchase of this house or you’ve paid down your current home loan enough that you’ve reached that 80% of home value sweet spot. Keep in mind, even if you haven’t paid the house down to 80%, you may still have more than 20% equity in the home if the markets have risen like they have in recent years. It’s a hot market and your house may be worth more than you think.
Home Value: $100,000
Home Loan: $80,000
Let’s look at this scenario. Someone has enough in their checking to pay their bills month-to-month and the rest is going into savings. They pay their mortgage every month and manage to stash some of their earnings away for a rainy day. Nice work nondescript fictional home owner! This person, if they wanted to, could pay off a huge chunk of their mortgage if they wrote a fat check to the lender for $10,000! That would pay down their principal on the loan and leave them with only $70,000.. but now they are broke and their money is tied up in the house. What happens when the rainy day comes?! That’s why a saver doesn’t dump all of their money into their mortgage, and this is how banks get paid; knowing you can’t pay it all so you pay the bare minimum for 30 years of your life… What if there was another way?!
Here’s my thought:
Home Value: $100,000
Home Loan: $80,000 (~$380 + taxes & insurance, @ 4.5% interest = ~$500/month)
100% HELOC: $20,000 available (minimum payment of 1.5% of balance)
What the heck is a HELOC? Basically it’s a second mortgage, leaned against your home. Wait! Don’t leave! I promise it gets better =). A HELOC works like a checking account, where the money is immediately accessible for those rainy days, but paying it back works like a quick money loan with simple interest based on a variable interest rate. You can write checks out of this account and every check cashed is borrowing money against your home’s value. So you might be thinking, “why the hell would I borrow money from my home to then turn around and pay my home?!”. The answer is interest rates paid toward principle.
Fixed home mortgages are front loaded with all of their interest. This means the first 10-15 years of you paying that fixed mortgage payment goes almost entirely to the bank. This is how you can be “paying down” a mortgage for 10-15 years and look at your loan statement and have only paid down maybe 10% of the actual loan amount; it’s all going to the bank! Again, we do this because the only way to get the money back out of this conventional loan is to sell your home. Let’s dig deeper into that fictional home owner:
If we take a NI of $30k and use our 1/4th rule of savings, that means our person is able to save roughly (NI * 12 / 52) = ~$7,000 per year.
Home Loan: $80k -> $50,000 ($500/month, fixed 30 years)
HELOC: $20,000 (@ 5.5% interest, $580/month, payoff in 3 years)
The total funds that we’ve been talking about are all the same. The difference here is where we are keeping our money. Money sitting in a savings account is doing nothing for us. We need that money to work for us until we need it for that rainy day instead of collecting dust in a savings account. So, after taking out a HELOC, we drain that, plus some of our savings account into the home loan.
Home Loan: $50k -> $49,000 ($500/month, fixed 30 years)
HELOC: $8,000, $12k available (@ 5.5% interest, $580/month, payoff in 1 year)
After 2 years of dumping all of your money into the HELOC instead of savings you’ve paid down your HELOC by $12,000 which gives you total spending power of (12 + 5 savings) = $17,000 for any rainy day that may come. Sure $12,000 is not the ($7,000/year * 2 years) = $14,000 you could have saved by simply putting your cash in the bank but you can see that you would have only paid down a whopping (maybe) $1,000 off of your home mortgage. And guess what? You did pay that down AND you paid down another $12,000!!! Keep going!
Home Loan: $49k -> $48,500 ($500/month, fixed 30 years)
HELOC: $0 ($20,000 available)
Congratulations, you paid off round 1, but it’s time to get back in the fight!
Home Loan: $48k -> $27,000 ($500/month, fixed 30 years)
HELOC: $0 ($20,000 available)
Home Loan: $27k -> $5,000 ($500/month, fixed 30 years)
HELOC: $0 ($20,000 available)
Home Loan: $5k -> $0
HELOC: $20,000 available (didn’t need it, but it’s nice to have this cushion)
Savings: $5k + $2k = $7,000
There are some hand-waving assumptions being made here.
- Variable interest rates will go up/down but stick around 5.5% for a HELOC. It could go up, but it could go down as well.
- This also assumes that you haven’t gotten a raise in 10 years!!! If interest rates go up slightly but you are making more money, it all sort of washes out to the same 10 year plan so you should adjust accordingly as rates change. Remember, it’s all about refilling your HELOC to then pay off more of that beefy mortgage..
I’m really excited to try this and I do hope that it will work. If you are going to try this or have done it, please let me know your experience @Ben_Quintero on Twitter.