Jharkhand Diaries

Why I chose to Pay off my mortgage early

PaidHouseOur family had just moved back home in the summer of 2015 to Boston from Malaysia after a 3 year international job assignment. As a result of low expenses in Malaysia, our savings had grown and we wanted to be done with renting after our move back to Boston.

We were in corporate housing for 3 months and we wanted to be done with renting. With a family of four and two little kids (4 and 1) at the time, we wanted to live in a home we could call our own. The housing market was hot and I think we were in the midst of a hot seller’s market and it still continues to be one today (Aug 2018). We made one unsuccessful offer (30K above the asking price) and were turned down.

About two weeks later we succeeded in the purchase of a house at asking price. It was an old 1959 house (a bit dated) but needed some updating. The asking was $728K and we ended up buying it at asking price. We had saved enough to put down 20% without touching our brokerage account and I chose an 7-year ARM loan with a fixed APR of 2.875%. I had set a goal to pay the mortgage off before the 7 year mark after which the interest rate would be adjusted.

The best part about buying the house was that I had not seen the house before making the offer. It was Mrs. Rebirthat45’s unanimous decision 🙂 What I liked about this deal was that she had lost her right to complain about the house later because it was her and her alone who made the choice. She did make a great choice. We loved our house while we lived in it for the next two years until May 2017. We still love it and I’m sure our tenants do now.

mortgage payoff

The chart shows the progression of our $580K mortgage loan that we paid off in about 2.5 years. We had been making extra principal payments in the first two years of the loan from our savings every quarter. In summer of 2017 when we moved to India, we rented our house and it became an income producing asset. We started making extra principal payments more aggressively through the rest of 2017.

2017 was a great year when our brokerage account appreciated by 37% and I was looking at sufficient liquid funds to pay off my mortgage. That is exactly what I ended up doing in January 2018. I was also growing wary of how much further the bull market had to run, and knowing myself I knew I’d play and experiment with my profits and may end up losing some of the gains. I continue to be pessimistic about the future returns of equity markets going forward and that is reflected in my current asset allocation (see the chart on my net worth page).

IRR of paying the loan off vs keeping the mortgage

My rental property has an IRR of 7.3 %. You can learn all about calculating IRR and download free excel spreadsheet to calculate IRR here. Had I chosen to keep my mortgage, my IRR on my house as rental property would have been 9.6 %. However there’s a lot of uncertainty in the latter IRR calculation. My 7/1 ARM had a fixed rate of 2.875 % only for the first 7 years, and in my latter calculation I assume that the 7/1 ARM rate would remain at 2.875 % after the 7 year period. It is likely that this would not be the case because rates have already gone up and my rate would be revised. The IRR of the project on keeping the mortgage would have been less than 9.6 %.

I sacrificed about 2% return at best by choosing to payoff the mortgage early. But what I bought with that sacrificial extra return is the certainty. The house is now mine. No part of it is now owned by a bank.

Had I chosen to keep the mortgage, with my current investment sentiment (which is pessimistic) I would have still parked my money in low returning conservative assets and the return on that would have been less than the 2.875 % interest I was paying on the loan. So It made sense to pay off the loan. That way I guaranteed myself a 2.875 % return on my funds that I used to pay down the loan.

I am completely debt free at 37. I own my home outright and I do not owe anybody a single $. Buy that’s a good feeling. So far, 6 months after paying off the loan I do not regret my decision. I may feel differently should the equity markets continue to offer returns in excess of 10% per year! Did I say I’m pessimistic of the future returns ?

At the end I asked myself two questions –

Would I regret paying off the mortgage if the markets continued to rally and return in excess of 10 % ?

Would I be OK losing a part of my capital should there be a strong market correction ?

To me, the second question was more important. I have become financially independent and I want to stay that way. I do not want to become financially dependent again. So capital preservation to me at this time is much more important than missing out on possible gains. Although I may be OK finding out that I missed a great run on the stock market, but would not be OK losing my capital.