We all know that to become financially independent you need to get your expenses down below the level of your investment income. It’s a remarkably simple formula but one that can seem unattainable. However the maths doesn’t lie…do it and you’ll have reached the promised land that is FI.
I’d wager that theĀ largest expense onĀ mostĀ household budgets isĀ housing be it in the form of mortgage payments or rent. The Office for National Statistics says thatĀ in 2013 UK households spend on average Ā£641 per month on housing (mortgages or rent) or Ā£897 if you live in London. If you’re living outside London and earning the average UK wage (Ā£27k) then you’re housing costs would represent 36% of your take home pay if you confirm to the norm.
So, if you can come up with a plan to eliminate or reduce your housing costs then you’ll put yourself in the enviable position of beingĀ well on the way to reaching financial independence.
Take a look around at the FI Babbas out there that are already living FI and you’ll soon notice they all have one thing in common, a laser like focus on achieving a reduced housing cost. This can be done either from living somewhere cheap or focusing on the rapid over payment of mortgages or ideally a combination of the two.
A few examples from the world of FI…
Jacob at Early Retirement Extreme took this to the extreme in order to achieve his freedom. Although he lives in a house now much of the accumulation phase of his journey was spent living in an RV. Now that might be too far for some people but it’s a fantastic example of one way to supercharge your savings rate by all but eliminating housing costs early in the journey.
MMM on the other hand is/was a bit more pragmatic. His view is to buy a nice house, one so nice you wont want to leave. Leaving your house usually ends up with you coming home with less Ā£$ than when you left so what he says makes some sense to some degree. It also helps massively that he has a background in construction so is a DIYĀ guru. This has enabled him to buy in a modest area and add value (pleasure mainly but I’m sure financial too) through his significant home improvements, and of course he’s mortgage free.
Here in theĀ UK we see the same pattern. Despite shamelessly bragging about his new swimming pool1Ā (that he’s no doubt been enjoying in the recentĀ heat wave), Ā the Escape Artist has eluded in the past to mortgages being like a chainsaw.
Then we have the Ermine who wisely managed to avoid the common middle aged folly by “having less house than my [ex] colleagues”.
If that isn’t enough evidence for you then I suggest you sit down and analyze your monthly spending and work out exactly what % of your net income flies out of the window on housing costs. Assuming it is a sizeable %, shut your eyes and imagine how much nicer the world would smell if itĀ was 0%.
UTMTsĀ Mortgage Journey
When we moved out ofĀ London a few years ago it was part of our master plan of living a simpler, cheaper life.Ā The main motivation was the fact that London housing is so expensive compared to areas that are commutable. OurĀ plan was pretty simple:
1. Continue to earn London wages by commuting back in to town
2.Ā Buy a modestly sized house for non London prices
3.Ā Pay the mortgage off as quickly as possible
We’ve been fortunate bothĀ in our timing and circumstances.
UnlikeĀ a few friends of ours we managed to keep our well paid jobs in the Finance industry throughout an unprecedented financial crisis. Until very recently we’ve had two good incomes to throw at mortgage overpayments. On top of this we’ve been sat on a variable rate mortgage throughout a time when interest rates have been at a record low for the last 6 or so year.
The last few years have been spent diligently following the mortgage overpayment rulesĀ to a tea. It’s perhaps not been the most exciting thing to do each month but the end goal has always been the focus.
Part way in to the journey we hit a wall…but we kept going. The motivation of checking the mortgage spreadsheet after each months overpayments wasĀ huge and perhaps the biggest single factor in keeping the momentum going.
Thanks (mainly2) to these efforts,Ā we’re now in a position to all but pay off the mortgage completely.
The reality is we won’t because part of the mortgage is on an interest rate of less than <1%. For this portion of the loan we have cash savings/investments earning more than that which have been earmarked against the outstanding capital. Should interest rates rise we’ll likely dispose of this investment capital top pay down the existing loan.
The details are unimportant here it’s the result that is of central importance.
In essence, we are now mortgage free.
Reaching this milestone is incredibly liberating. We live a relatively simple/low cost lifestyle so the major ‘mandatory’ expenses we have left are utilities, council tax and food3Ā – none of which couldn’t be funded by a shelf stacking job in Tesco if push came to shove. After that our expenses are linked to our ‘wants’.
At times, particularly at the start of this mortgage overpayment journey it felt like progress was painfully slow. However I can look back now and enjoy the fruits of an almost obsessive determination to rid ourselves of mortgage debt4.
Once the snowball that is capital repayment got rolling, it became easier and easier to reach the zero balance.
Watching it happen each month was the perfect display of compound interest at work. The more capitalĀ that wasĀ paid off, the less interest we wereĀ charged, enablingĀ us to pay even more toward the outstanding capital.
Compound interest is one of those things that takes a while to get hold however when it does, it’s a beautiful thing to behold.
Hang On,Ā Isn’t There a Better Way?
Some will point out that I could have quite easily have achieved a better investment return by instead investing all of those monthly overpayments. With the benefit of hindsight I have to agree with them 100%…up to a point.
Over paying a mortgage can be seen as a risk free investment. Each payment reduced my capital and thereby future interest liabilities, leaving me with more disposable income in the future. If I’d been pumping the money into the stock market all these years I’d have been worrying about all sorts of things such as:
- Is the market aboutĀ to crash?
- If the timing my stock purchasesĀ off?
- Portfolio diversification/rebalancing
- Are my investment returns beating theĀ mortgage interest rate?
- etc etc
Instead I got to experience a warm satisfying feeling every time I logged into my bank account and instructed another overpayment to the mortgage company. No worry, no tracking returns just theĀ knowledge that I was getting a guaranteed return and was definitely moving closer and closer to being mortgage free and nearer to becomingĀ financially independent.
In any financial writing there is always much mention of risk v reward. To date I’ve not encountered an investment that maximizes the payoff between risk and reward (including non monetary reward) anywhere near as much as paying down the mortgage.
Even if I had the benefit of hindsight (knowing I could have made more investing the over payments instead) I’d stillĀ have chosen mortgage elimination instead.
So What Next?
Over the last few years we’ve been pumping lots of extra cash into additional capital repayments each month. Going forward we’ll have any money that previously would have gone to the mortgage company spare toĀ either invest in ISAs,Ā further deleverage the buy to let portfolio or to put towards other investments such as SIPPs, peer to peer lending etc.
Of course just because you’ve got rid of your mortgage doesn’t mean your housing costs are zero in perpetuity. Owning a property means you need to pay for it’s maintenance too. We’ll still need to be financially ready for the typical things that crop up from time to time (roof repairs, new boilers etc).
Despite this it feels like the money tree is about toĀ get a large shot of fertilizer. So long as the spare cash flow doesn’t all get spunked on designer changing tables then I hope to be able to spend the next couple of years building our income producing investments at a much faster rate than before.
Changing Risk Profiles
Knowing that you own your home outright is incredibly liberating. Suddenly as well as having more disposable income to invest I am also feeling more bullish about taking risks with my spare capital…safe in the knowledge that there is a roof over my head that has been paid for.
It finally feels like FI is significantly closer than it was when a mountain of debt was attached to the place where I rest my head every night.
Notes:
1 OK, we’ll let him off as it is rather modest š
2 Some reshuffling of finances has enabled me to pay a decent lump some to get us over the line though as stated the hard work has been done by monthly over payments
3 I’ve ignored my extortionate commuting expenses (annual train season ticket) here as it is tied inextricably to my job. The moment I quit work (or am fired) that expense will cease.
4 Of course I still have a material amount ofĀ buy to let mortgage debt but in all honesty I don’t worry about that at all due to my low risk approach to BTL.
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