It’s one of the most strongly recommended pieces of advice when it comes to early retirement strategies: You need to pay off your mortgage as soon as possible and become debt-free.
While the benefits of no longer paying for your house are obvious, this advice can be somewhat conflicting.
If I want to retire, shouldn’t I be focusing on saving instead of paying down my mortgage?
Since I’m not made of money, where should I prioritize my finances?
The trick behind the magic of paying off your mortgage early is in knowing how it can affect your overall retirement goals, and how many years it can knock off your timeline. In this post, we’ll talk about how this strategy can be useful and just how much sooner you may be able to retire because of it.
The Relationship Between Your Expenses and Savings
Within any successful retirement plan, your goal should always be to find an alternative way (other than working full time) to replace your living expenses. Generally, this is accomplished by saving up a large sum of money (i.e. your nest egg) and living off a small fraction of it. Most experts recommend that you withdraw approximately 4 percent of your savings each year to cover your expenses during retirement. Therefore, the following relationship exists: Your nest egg should be approximately 25x your anticipated retirement expenses. Another way you could think of this conversion is to say that for every $1,000 of income you’ll need, it will require you to have saved up $25,000 in your nest egg.
Less Expense Means a Lower Nest Egg
Keeping this 25x rule of thumb in mind and working backwards, it stands to reason that one way you could lower your retirement savings goal would be to find a way to cut back on your expenses. There are many possible things and activities you could cut out. But for most people, to cut expenses significantly they should eliminate their mortgage. To illustrate this point, let’s see how much money you could potentially save by no longer having to make a monthly house payment.
For starters, we’ll say you have a mortgage of $1,300 per month. By paying it off early, you could wipe $12,000 of annual expenses from your budget. Using our 25x rule, this works out to $300,000 less you will need to save up in your nest egg! Now let’s put this all together from a broader perspective. In the U.S., the median income is roughly $60,000 (Guzman, 2018). This means that if we assume you’ll need 80% of your current income to cover your anticipated retirement expenses ($48,000), then your target nest egg amount would be approximately $1.2 million.
However, by paying off your mortgage early with the numbers were used above, this would decrease your nest egg target by over 30% to $810,000. Depending on how much money you are saving per year and what type of investments you have, that could potentially knock years off of your retirement goal timeline.
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How Can I Payoff My Mortgage Earlier?
While paying off your mortgage early may seem like a huge task, don’t be overwhelmed. This task can really be accomplished in smaller chunks than you think. The key is to add small, regular payments to the principal portion of your mortgage payments. We’re not talking very much. A few bucks here and there.
Using a popular online mortgage calculator, we can see that amounts as low as $100 per month extra towards the principal will shave 4 years and 2 months off of a $275,000 mortgage with a 4.0% fixed APR and 27 years remaining on a 30-year mortgage. $250 extra per month will knock out 6 years and 9 months, and so on. Saving an extra $100 is something that can be accomplished by exerting some discipline and making smarter purchases. Strategies, like not going out to eat so much, staying away from the mall, and challenging your bills, can all be easy, effective. There are literally hundreds of things you could try.
Your goal should be to strike a balance between paying off your mortgage early while still saving as much as possible in your tax-deferred accounts. That way, by the time you are finally ready to pull the plug on working, you’ll have the double benefit of no longer having to make payments on your home while sitting on top of a substantially-sized nest egg.
Author bio: This article comes from Mr. WM at My Wealth Manifesto, a money blog dedicated to taking a deeper look into all things personal finance. Join us as we find new ways to pay down debt, save more cash, and build our way to financial independence.
Guzman, G. (2018). Household Income 2017 – American Community Survey Briefs. Retrieved from https://www.census.gov/content/dam/Census/library/publications/2018/acs/acsbr17-01.pdf