Imagine you are a young guy and you want to buy a house.
You go to the Bank to borrow £250,000. After all, everyone else is doing it…how hard can it be? You are 25 and have the rest of your life to pay it back.
The bank manager looks at you, checks that you have a job (wearing a tie helps here) and are not a convicted criminal, shakes your hand and tells you £250,000 will not be a problem. Well that was easy!
But, as Steve Biddulph tells the story in Manhood, there is just one problem – something else happens that you weren’t expecting and wasn’t in the adverts.
The bank manager takes out a jar. You have to leave behind one testicle in the Jar which is then locked away in the Banker’s safe for the 25 year mortgage term, along with all the others.
Now you have future interest payments to meet. The other nasty side effect is this:
“If ever in your life you get the urge to do something risky, exciting, different or adventurous, chances are you will not because you won’t have the balls to do it. Somehow, to be a free man, you have to escape this trap.”
“You could live in the country where houses cost less. You could stop competing with your neighbours and drive the oldest car in your street. You could give your children more of your time, instead of a private school education…Even reducing this, claiming back some of your money and time, you can be a freer man”.
This captures the essence of what I am talking about on this blog.
When I bought my first house, aged 26, the “logic” went something like this:
1. My girlfriend said we should buy a house
2. Everyone says you can’t go wrong with bricks and mortar…and prices seem to be going up…best get in quick!
3. Am I not an upwardly mobile, tycoon of the future? Yes, indeed I am! I will therefore need a house that is befitting of my status
4. I therefore want to own the “best” (read most expensive) house possible
5. To buy the most expensive house, I’ll borrow as much as the bank will lend me
6. I will then be happier…because everyone knows that having more shit makes us happier.
Please note here the absence of any original thought, logic or financial analysis to back up one of the most important financial decisions of my entire life. Lemmings have jumped off cliffs with more analysis to back up their decision than this.
Now, here is one of the ironies of life. I ran a lousy decision making process but, thanks partly to luck, got a good outcome. So, how did this end up working out OK for me?
Firstly, a house is a productive asset – it provides shelter, security and a store of value that tends to rise over time along with growth in the economy. But be careful of the “stuff” that people associate with a house purchase. For the avoidance of doubt, plasma TVs, Xboxes and pink fluffy cushions do not count as productive assets.
Second, a mortgage can be a effective motivational tool. Once we’d moved in, I gradually realised the implications of what I’d signed up for. I feared default and eviction. I channelled this fear into action – this helped keep me focussed on work and chasing the next pay rise and bonus.
I respectfully submit to you that, if you have a large mortgage and you are not at least a little scared, then you do not fully understand your situation. There is an optimal level of mortgage fear. A little edge of unease can be helpful as motivation to get out of the hole as quickly as possible. Too much fear, however, can paralyse and persistent debt worries will eat away at you.
Repaying the mortgage provided a clear, achievable goal. I set aside a regular monthly amount (in addition to the minimum payment required by the banks) for paydown. Every time I went to the bank to do this, they would run off a little slip that showed me the new (reduced) monthly payment. Ker-ching!
All the bonuses and any other spare money that I could scrape together got thrown at reducing that mortgage. Slowly but surely, this created a virtuous circle. The more I reduced the mortgage, the lower the monthly interest became. The lower the monthly interest became, the more free cash flow I had available to throw at reducing the mortgage.
The potential escape artist pays themselves first. In other words, put the mortgage over-payment savings on auto-pilot with a direct debit that comes out of your current account straight after you are paid. That has a helpful side effect of helping to create an artificial environment of scarcity for the rest of the month that helps you control your spending. In contrast, the sucker waits until the end of the month and says they’ll save whatever is left. Guess how much that will be.
Third, having a mortgage always meant that I had a great investment opportunity in front of me. No need to scour annual reports, research companies or read the Financial Times. At an interest rate of, say, 6%, I always had a tax efficient and risk free way to put money to work by paying down the mortgage.
Tax efficient because the “income” from mortgage repayments (i.e. lower interest costs) is tax free. Whereas if I had saved the spare cash flow into a savings account, I would have paid income tax on it. For a 40% taxpayer, this turns a 6% (net return) investment into the equivalent of a 10% (gross return) investment.
On reflection, risk free is probably the wrong description for mortgage repayment as an investment choice – it makes sounds like it is risk neutral. Actually, its much better than that. You have reduced your leverage, reduced your stress and increased your robustness to future shocks.
There is a healthy debate to be had here for savers. Should they pay off the mortgage or should they use the cash to buy other productive assets (e.g. shares) in a SIPP or ISA?
There is no single right answer to this. The most important thing is to focus on saving as much as you can….whether you invest it into a pension or ISA, property or shares is a secondary consideration.
For me, the priority was to focus on smashing the mortgage whilst paying into a workplace pension and buying shares to learn as much as I could about investing. There is no one right answer for everyone but, if you invest whilst you still have a mortgage, this is equivalent to borrowing money to buy shares.
The potential escape artist prioritises their attention on the big wins and the quick wins. Housing costs (e.g. mortgage interest) are the big one for most people so this is a good place to start looking to attack your cost base.
My view is this. A mortgage is like a chainsaw. Its a powerful but slightly scary tool to be used carefully for a short period of time in a domestic situation. If you get it wrong, it might lop off a limb or two.
If you are in the hole with a large mortgage, the good news is that you can climb out.
Start now.
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The Escape Artist 
“If ever in your life you get the urge to do something risky, exciting, different or adventurous, chances are you will not because you won’t have the balls to do it. Somehow, to be a free man, you have to escape this trap.”
I love this quote! I couldn’t agree more. As long as the bank dictates what I do, whether it’s a residential mortgage or a business loan, I feel I’m working for “The Man” whether I’m self-employed or not.
Once I experienced what it was like to have no one (other than the government at tax time) to answer to when it came to debt/money, I swore I would do my very best never to go back.
Exactly F2P – I am sure that you will never go back.
P.S. I loved the post over on your website about the House TV show…its a great subject which I intend to return to in future posts here
Glad I could offer food for thought. I’ll be popping by to read future posts.
The vicious cycle of a mortgage put into great perspective, its girl, mortgage, job, raise, and work hard so it doesn’t all blow up.
Great post Mr TEA! I pity the fool with a large mortgage! (See what I did there?)
When we finally move in a couple of weeks we’ll have what is considered a medium sized mortgage nowadays but it still invokes the fear in me when I think about it. As you say this is a good thing! My plan I think, as arbitrary as it sounds and is, is to put 50% of savings into overpaying the mortgage and 50% into other savings and investments. I want to get that guaranteed return, but also need to have a chance of compounding some investments as early as possible.
Nice. 10 extra points for the reference to The A Team, Firestarter
Inspiring and superbly written blog. I have been poring over it since Monevator linked me to the site at the weekend. I am 39 and two years into a serious tilt at achieving FI; I have a long way to go but am growing in courage along the way. I’ve spent those two years intensively building up my cash position (by cash I mean work pension, SIPP and ISAs) but I think I’m ready to pay a bit more attention to the mortgage now.
It struck me today that we are in a highly dynamic situation wrt to the pursuit of FI. Legislative goalposts are being moved with incredible frequency. A daily unveiling of new pensions legislation (personal and state), changes to ISAs and all against a backdrop of highly active central monetary policy, geopolitical risk and a forthcoming general election. Against all of that I’m finding it hard to pick a winner, so may adopt a simple asset allocation model of 1/3 pension 1/3 ISA 1/3 mortgage overpayment as a way forward.
Sean – welcome to the site and thanks for your kind words. If you like the site, please “pay it forward” and send the link to friends.
Recent changes to pensions, ISAs and income tax allowances have all been very helpful for those pursuing FI. The changes have provided more choice and freedom and made the tax system a little fairer (even though its still stupidly over-complicated).
In relation to investing your cash, roughly right is better than precisely wrong. With a 3 way split between pension saving, ISAs and mortgage payment, you are definitely in the “roughly right” category.
So keep it up and all the best with your journey to FI.
Excellent read, I found this blog courtesy of Mr Simple Living in Suffolk. I’m with you all the way with killing the mortgage, but I have a dilemma with that. The fallout of an outstandingly obscene property bubble blown up by successive governments since the late 90’s, means I (and many others) can’t afford to get a mortgage to pay off in the first place (Greater London here). This is a major stumbling block on the road to FI. I’ve had to solve this problem somewhat back to front. I’m paying off my mortgage, I don’t have, to the Bank of Me. Put another way I’ve done myself a nice boring spread sheet, looked at the today price of my target house, added 5% HPI to that each year for 10 years (they’ll be anarchy on the streets if that comes to pass).Then I’ve then targeted my savings/investments accordingly (on top of an existing lump sum), and there’s barely any difference in cost when I factor in mortgage interest, maintenance, various mortgage fees etc on one side and my saving/investments on the other. I hope this doesn’t sound nuts, but it’s the only way I can do it, and at least I can lose my job at any time and have zero debt. I won’t be buying anywhere near the South East, I’ll earn London money and then get out. My saving grace is I’m not paying any sort of serious rent, if I was the above would be nigh on impossible. I’m simultaneously loading up my DB pension to the max and should be out on the tree line in 9 years, 9 months.
If I could get FI before then I’d be over the moon, but the cost of housing is killer.
Starla – it doesn’t sound nuts at all – in your situation, renting and investing (rather than servicing a monster mortgage) gives you options
If your mortgage will be paid off in 14 years at a 3.5% rate of interest, would you agree that it makes more sense to invest (in a taxable account as all tax-deferred accounts are maxed out), rather than pay extra toward the mortgage? If the mortgage interest rate were higher, 6% as in your example, I’d have an easier time with the decision to pay down the mortgage rather than invest the spare coin in my taxable account (Vanguard index funds).
Yes, that makes sense if you are comfortable with a slightly higher risk & reward profile….especially if you have a fixed rate mortgage which I think are the norm in the US. I do worry about people on a variable rate mortgage…how will they cope if interest rates were to shoot up to say 17% (the level they reached in 1981)? I do not want to see you & your 3 cats out on the street, UB.
The 3 (pampered and lazy) black cats asked that I express their gratitude for your looking out for them. They are very much against returning to life on the streets.
I would agree with you, except that with fixed rate mortgages (at least in the US) you can’t reduce your monthly payment by paying down the mortgage. This is a very important distinction. So if you have a high mortgage but a low fixed interest rate, you already most likely have a very limited amount of extra money after paying the mortgage, and the only benefit you get from putting it towards over-paying the mortgage is that your loan ends a little earlier. You don’t gain any cash flow until the loan is completely paid off. In addition, you would probably want to put anything you have left over into investments that are likely to yield much more return than your low interest mortgage.