The path to financial freedom can be challenging. Our story is not one of those “I paid off $200,000 in debt in two years” kind of story. I am envious of people who have the discipline to pay off large amount of debt in a short period of time. However, for most of us the reality is that life and temptations sometimes get in the way of our goals.
For example, when the transmission went out in my 2005 Pontiac Grand Prix I could have worked hard to find a decent vehicle for much less than I paid for my newish car. I ended up getting a 2013 Hyundai Sonata for about $16,000. Even though we were in debt payoff mode, we took out a loan to finance the purchase. This just goes to show how easy it is to stray from the path. We ended up paying off the loan in about a year, but it definitely set us back.
Then there was the rental property we almost purchased in 2016. Once we became debt free besides the mortgage, we turned our focus to buying rental property. We actually had a house under contract though ended up backing out after the inspection. In hindsight the inspection wasn’t that bad and the deal overall was pretty good. However, two things spooked me. The first, was we were planning to fund the purchase and repairs on the rental house with a home equity line of credit (HELOC). The plan was to purchase with the HELOC (to take advance of the benefits of being a cash buyer) then refinance into a traditional mortgage. Not a bad strategy overall, though the thought of something going wrong with the rental and impacting our personal residence scared me. Additionally, I planned to work with a partner on the deal and there were a few red flags that were coming up regarding this individual. In the end, even though I probably missed out on a good deal I think the correct decision was made to pull out.
After the rental house deal fell through we decided to buckle down and throw everything we could at the mortgage. We have loosely followed the Dave Ramsey plan throughout our pilgrimage. I’ll admit, if we followed his plan more strictly, we’d probably be out of debt already. However, we don’t do great with restrictive plans so there’s also the possibility that we would have burned out and be in a worse place today than if we would have followed the plan exactly.
I’ll use a future blog post to provide additional detail around the aspects of the Dave Ramsey plan that we followed and the aspects we haven’t. For this post, I thought I’d discuss one of the more controversial aspects which is baby step 6. Baby step 6 in the Dave Ramsey plan is to pay off your personal home mortgage. I’ll admit that I’ve struggled with the right decision here at times, hence the pursuit of a rental property purchase without the mortgage on our personal residence being paid off.
The argument against paying off the mortgage, especially in our low interest rate environment, is that your money may be better spent investing elsewhere. For example, the interest rate on our personal residence is 4 percent and we could potentially take the additional payments we’re making on the mortgage and invest it in stocks, rental property, or a business that generates a return higher than 4 percent. If our situation was different and I was early in my career with a large mortgage, we may have been more inclined to try to build up passive streams of income to cover the cost of our mortgage. There are also tax benefits for having a mortgage for those of us who itemize deductions. I’m sure there are other arguments though these are the ones that I seem to hear the most.
The argument for paying off the mortgage is in a lot of ways more behavioral than fundamental. What I mean by this is the peace of mind of not owing anyone a dime of debt can provide the freedom to make certain decisions that you may not otherwise be able to make when you are in debt. For example, if you don’t have any debt and work a job you hate, you may be able to move to a job that pays less and is more fulfilling. There is also the argument that paying off the mortgage is basically a guaranteed 4 percent return on your investment. There is nowhere in the market place where you can get a 4 percent return on investment with little to no risk.
Last year (2016) we took a step back and thought through all of the pros and cons of continuing on with the Ramsey Plan through baby step 6, or to shift our focus to other investment options. We decided that we were going to get laser focused on getting the mortgage paid off for a few reasons.
The first is that we felt we had a realistic chance of paying the mortgage off within a relatively short period of time (2 to 3 years) if we really focused and started making aggressive payments. Since we have paid down the rest of our other debt and have done a decent job preventing lifestyle creep despite making more money today than in 2011 when we started our pilgrimage, this was a realistic option. I know this is not an option for everyone, though the steps we’ve taken to pay down student loans, car payments, and other debt has given us this flexibility. With my wife working full time for the last few years and me being fortunate enough to receive a few promotions at work, we were well positioned to take on this challenge. If we were in a higher cost of living area and we didn’t think it would be realistic to pay off the mortgage in a short period of time, I would potentially reconsider as I wouldn’t want to hold off on investing in passive streams of income for too long.
The second is from experience it can be really easy to use money that you plan for investments in other large purchases. For example, looking back a big reason why I ended up purchasing a $16,000 vehicle instead of something decent for $5,000 or $6,000 was because we had built up a decent amount of savings that we planned to use for investments. Well, instead of investments it ended up just going into the purchase of a better vehicle. On paper, this was a foolish decision given our goals. However, we are human and fell into the temptation of a nicer car. Whenever I hear someone say that its silly to pay off the mortgage early because of being able to get higher returns elsewhere or to take advantage of the tax benefits, I also question where that additional money is really going. For those of you more disciplined than me, it may very well be going to investments that generate a higher than 4 percent return and provide passive streams of income. However, my guess is that for most of us its going to lifestyle inflation, nicer cars, home remodeling, etc.
Keep in mind that baby step 4 of the Dave Ramsey plan is to invest 15 percent in retirement accounts, which we are doing. So even though we aren’t investing in real estate or stocks outside of our work retirement accounts, we have been making contributions at least up to the company match since starting at our jobs. I just don’t want people to think that we are completely ignoring investing opportunities as we are paying down the mortgage.
We are currently making quadruple payments on the home mortgage. By sticking to this approach, we should have the house paid off by next summer. We have an aggressive goal to get it paid off by March 2018 when baby number two is due. I’m not exactly sure where the money will come from, though its not a bad thing to set stretch goals.
Thanks for reading!