Right now my husband has a very well paid job. But it's a contract job and the contract will end a year from now. After that, chances are very high that he will take a substantial paycut, possibly as much as 50%, though we hope it won't be that severe. We're very fortunate that his current salary is high enough that even half of it would be enough for two frugal people to live on comfortably in our part of the country. But going from a great paying job to a decent paying job is always an adjustment.
Knowing this, we've devised a game plan for the next year. With a significant amount put away for retirement, and no debts other than our mortgage, we're well situated for reduced financial circumstances. Still, less than two years into the 30-year term on our mortgage, the remaining principle owed is over $200,000, and that's with some extra principle payments already made. Our goal then is to throw every extra penny that we possibly can at our mortgage over the next year. Specifically, we want to knock an extra $50,000 off the principle, over and above what would be paid down by our obligatory monthly payments. Let's look at the mechanics of how this is would work.
A simple division of $50,000 by 12 months gives us an additional monthly payment of $4167. Ouch! That's a hefty chunk of change, and an ambitious repayment plan by any measure. We know this is a difficult goal, and we recognize that we may not succeed, though we're certainly going to try our best. Because of the way mortgages work, we don't quite have to come up with that much money each month in order to meet our extra $50k principle reduction goal. But this early in the term of our 30-year mortgage, most of our regular monthly payment is still going to interest. So we don't see the power of compounding working in our favor very much yet. Still, as we make each extra monthly payment, a larger and larger portion of our regular monthly payment (about $1450) will be applied to our principle balance, instead of interest.
Our lender has a nice amortization calculator on its website, with all our information automatically calculated. If your lender doesn't have an automated calculator on their site, you can find one that anyone can use here. You'll have to enter the details of your own mortgage though. We used the calculator to figure out what our balance would look like a year from now under a few different payment plans. With no additional payments at all, the reduction of our principle balance after one year would amount to just $4000. With an additional monthly payment of $4167, our principle balance would go down by $55,700 after one year - just slightly more than our goal requires. (Remember, our goal is an additional $50,000 reduction. So the total reduction needs to be around $54,000.) To find the "sweet spot" - the lowest monthly amount that would let us reach our goal, I plugged in various amounts for the additional monthly payment, narrowing in on that total reduction of $54k.
After a little trial and error, I found that we could meet our goal with an additional monthly payment of about $4050. That's still quite a lot of extra money to come up with each month. In fact, it's about half of our net monthly pay. We have enough breathing room in our monthly budget already that we can fairly easily come up with $3400 per month to contribute to this goal. The remaining $650 per month is going to be a real stretch for us though. There's a strong temptation on my part to raid our cash emergency fund to achieve our self-imposed goal. That $12k currently sits in a relatively high interest savings account, so that it's easily available to us at any time. But even a high interest savings account doesn't match the interest we're paying on the mortgage. The math suggests we'd be better off putting that money towards debt reduction. However, that would leave us without an emergency fund, and vulnerable to increased debt if we run into an unforeseen financial crisis. So, as tempting as it may be, we're leaving that money where it is.
The obvious adjunct to paying more money each month is to try to secure a lower interest rate through refinancing. I tried this recently and we were turned down, even though our credit rating is excellent. Partly this is because we already have a fairly good interest rate, and partly because real estate values have taken a bath since we bought our home. According to the loan officer I spoke with, the automated value now assigned to our home is $33,000 less than we paid for it. We could contest that evaluation by paying for an individual appraisal. But even then we might not secure a better rate of interest. So for now we sit tight. But I'll be keeping an eye on interest rates. If it looks like we could get a better rate, we'll definitely try again.
Our purpose in this plan is threefold. First and foremost, we want to get out of debt as quickly as possible. Secondly, by devoting so much of our take-home pay to this debt, we are in a sense preparing ourselves for the day when that money is no longer available to us at all. In other words, we're training ourselves to live on a much smaller monthly budget. Thirdly, by reducing our principle balance and increasing our home equity, we're positioning ourselves well for refinancing our mortgage or even taking a home equity loan somewhere down the line, if we should need it. The home equity loan scenario is a likely one, as we would eventually like to build our retirement home. The money for that construction might very well have to come from the equity in our current home.
A year from now, we may have to go back to making just our minimum monthly payments on the mortgage. But whether we succeed in our ambitious goal or not, we will have made a significant dent in our principle balance, and a larger portion of each of our regular monthly payments will be applied to our principle, instead of lining the coffers of the lender. We won't feel like losers if our principle reduction over the next year is "only" $45,000 rather than $54,000. Instead, we'll feel a sense of satisfaction that $600 of our $1450 monthly payment is being knocked off our principle rather than the $360 it would be had we not attempted this goal at all.
Note: I posted an update detailing our revised approach to this goal.
12 hours ago