Two sizable pieces of Frugalwoods-relevant news occurred this past spring:
- We paid off the mortgage on our primary residence in Vermont!
- Mr. Frugalwoods retired!
These both happened amidst the flurry of the pandemic, our stint as unintentional homeschoolers and, of course, maple sugaring season.
I promised to share the details once the sap stopped flowing, we got vaccinated and the kids went to in-person school (PRAISE BE). These two events are correlated since we didn’t want to carry a mortgage once Mr. FW retired early.
Does Liz Still Work?
Well, kinda. I continue to work part-time as a writer, but my income pales in comparison to what Mr. FW was pulling down, which makes his retirement the more seismic change for our overall household finances. I left my full-time office job back in 2015 and have been freelance writing (including writing a book) ever since.
I love what I do and have no plans to quit! But I also have no plans to work full-time. I like my part-time schedule because it allows me to be with the kids and spend a lot of time outside working on our homestead. At any rate, this is not about my favorite topic (moi…. ), so I’ll try to get back on point.
Reasons to NOT Pay Off a Mortgage
Longtime readers well know that I’m not a “pay off your mortgage at all costs” evangelist. In fact, I have many times counseled against it in Reader Case Studies over the years. I’m not philosophically anti-mortgage and think that in many instances, it makes a ton of sense to keep a mortgage because when you pay off a mortgage, you’re limiting the growth potential of your money.
Here are some reasons NOT to pay off a mortgage:
1) It’s a huge opportunity cost.
When you pay off a mortgage, you’re missing out on the potential investment returns you’d enjoy if your money was instead invested in, for example, the stock market or a rental property. A paid-off house essentially returns the rate of your mortgage interest rate.
For example: if your mortgage interest rate is fixed at 3.75% and you pay if off, you’re getting a 3.75% rate of return, which is honestly pretty low. By comparison, historical stock market trends demonstrate that–over many decades of investing–the market delivers somewhere in the range of 7% annually. That does not mean 7% every year, it means a 7% average over the lifetime of an investor.
2) A paid-off house is an illiquid asset.
You can’t use a paid-off house to buy groceries or fix your car or pay for health insurance if you’ve lost your a job. Yes, you might be able to get a Home Equity Line Of Credit (HELOC), but that’s not a guarantee and certainly not if you’ve lost your job.
Tying up ALL of your excess cash in a paid-off house is a dangerous proposition. Sure, you could sell the house, but then you’ll need to pay for somewhere else to live.
Before even considering paying off a mortgage, you should have all of the following lined up:
- A robust emergency fund of, at minimum, three to six months’ worth of your living expenses, held in an easily accessible checking or savings account.
- No high interest rate debt.
- Retirement investments (i.e. a 401k, 403b, IRA, Roth IRA, etc) that are fully funded as appropriate for your age, goals and anticipated retirement date.
I would further argue that you should also have at least one other form of investment (in addition to your retirement). Along with the above, I have:
- A brokerage account of diversified total market, low-fee index funds, both domestic and international (aka stocks)
- 529 College Savings accounts for both of our kids
- A Donor Advised Fund (DAF) for making tax-advantaged philanthropic contributions
- An income-generating rental property
You certainly don’t need to have this entire second list of items lined up, but you should absolutely have the first three on lockdown. If you want to read more about how we manage our money, check out: How We Manage Our Money: Behind The Scenes of The Frugalwoods Family Accounts.
3) A mortgage is a nice hedge against inflation.
Inflation is when money becomes less valuable. The good thing about a mortgage is that it’s denominated in the dollars you originally paid for the house. Thus over time as inflation increases, which generally happens, the money you’re using to pay off your mortgage becomes “cheaper.”
So Why Did We Pay Off Our Mortgage?
Since I just outlined some very good reasons NOT to pay off a mortgage, why on earth did we do so?
1) Better than bonds.
Remember how I mentioned that when you pay off a mortgage, you essentially lock in your mortgage interest rate as your rate of return? That’s what we decided to do. Our interest rate was 4.0% fixed for 30 years. Thus, we locked in a 4% rate of return. Not a very high rate, you’re thinking, which is true if you compare this to average annual stock market returns. But, if you compare this to the current bond market, 4% is actually not bad.
The calculation we made (in spring 2021) is that paying off our mortgage in this interest rate environment is akin to a bond allocation for our portfolio. Bonds are typically safer, less volatile, lower return investments, much like a paid-off mortgage. In general, the safer the investment, the lower the rate of return you can expect.
2) Paying off your mortgage at the point of early retirement dramatically decreases your sequence of returns risk.
This is the primary reason undergirding our decision. In paying off our mortgage, we traded maximum possible end value for a reduction in variance. When you pay off a mortgage, you’re not going to end up with the highest dollar return at the end, but you’re also way less likely to run out of money. After you’ve finished the accumulation phase of life (i.e. when you retire), the importance of absolute rate of return is then, necessarily, balanced against the sequence of returns risk.
This represents a willingness to trade the potential of having a higher net worth at, say, age 80 than running out of money at, say, age 70. Further (and related to #1 above), if you haven’t paid off your mortgage AND are holding low-yield bonds, that position makes no sense because then you wouldn’t be benefiting from the higher appreciation of the stock market and you’d be open to sequence of returns risk.
If you simulate retirement over the course of known financial history, there is a very specific set of circumstances whereby a person fails (runs out of money) in retirement. The circumstance for failure is that you retire right before a stock market crash AND high inflation with low returns (i.e. the 1970s).
The greatest danger to the next 50 years of your economic viability comes in the first few years after your retirement. For example, if you retire on Monday and start to take 3.5% of your investments annually to live on and then the stock market crashes by 50% on Tuesday, that 3.5% draw down is now 7%, which is a much riskier position.
The broader point is that, when you pull the trigger to retire, it’s likely the market will be high because that’s when you’re going to hit the net worth number you’re comfortable with. And so, a reasonable thing to do is to pay off a mortgage to lock in that savings going forward. By paying off your mortgage, you are reducing your reliance on market increases.
What’s Your Drawdown Percentage?
Right now it’s 0%. Our longterm plan is to take no more than 3.5% out of our investments annually. However, this percentage will fluctuate over time thanks to the income from our rental property and my freelance work. In years where the rental doesn’t incur capital expenditures and I continue to earn money, we won’t need to draw down anything. In other words, we will live off of our rental income and my income. Conversely, in years where I make less money and/or the rental needs major repairs (i.e. a new roof), we’ll likely need to pull out more than 3.5% in order to cover our expenses.
Ok enough from me. Early Retirement Now came up with this concept and did all the research behind it, so you should really go read what he has to say about it: The Ultimate Guide to Safe Withdrawal Rates – Part 21: Why we will not have a mortgage in early retirement.
How To Pay off a Mortgage
If you’re considering paying off your mortgage, and if you’ve met at least the top three criteria outlined above, you’ll want to plan ahead. You don’t want to liquidate stock and pay capital gains taxes in order to come up with the cash to pay it off.
Ideally, you want to slow or stop investing and keep money in your checking/savings account. In so doing, you are indeed missing out on potential market gains, but you’re also not going to incur capital gains taxes. Nor will you “lose” this money in the event of a market dip. In general, you don’t want to invest money you’re going to need in the near future.
For more on why to remain invested and not fear the dips, check out the cautionary tale in this Reader Case Study.
Mr. FW’s Early Retirement
Ok enough about the mortgage. The second profound life change this spring was Mr. FW’s early retirement! With that, we’re now officially FIRE’d (financially independent and retired early), with the caveat that I continue to work part-time as a freelancer. Mr. FW loved his job as a software engineer and was with the same company for 14 years. He started on the ground floor as the fourth employee and one of his duties was to empty the office trash cans (although “office” is a strong word for the damp, carpeted room above a bar they initially worked out of). He’s proud of the work he did there and feels a strong sense of commitment to the organization. But after 14 years, he decided it was time to bow out and let others take the helm. We began working toward FIRE in April 2014 and, synchronistically, he retired seven years later in April 2021 at age 37.
What’s Mr. FW Doing Now?
What isn’t he doing would be the more apt question. He doesn’t have any plans to dive back into a “real” job and is enjoying the time, space and freedom of our homestead. He serves on two different non-profit boards in our community and also does a lot of hands-on volunteer work (he’s currently helping build a new accessibility ramp, entryway and front porch at our community library).
He tends our gardens and fruit orchards, he built our chicken coop this summer, he makes maple syrup, fells trees, splits firewood, repairs our many farm machines, mows our fields, hikes, picks berries. He parents our children, takes them to school and reads them books, brushes their teeth and sings them goodnight. He cooks dinner and cans tomatoes from our garden. He helps friends and neighbors when they need it. He makes bonfires. He enjoys life and we enjoy him.
What About Health Insurance?
Astute readers will note that Mr. FW’s job provided our health insurance. This coverage terminates at the end of this calendar year and so we’ll be signing up for insurance through the Affordable Care Act (ACA) during the next open enrollment period. I can share what plan we select if that’s of interest to folks. This expense will start showing up in my Monthly Expense Reports in January 2022.
Privilege and Gratitude
FIRE is, above all else, a privileged position. It is not something we take lightly and we are profoundly aware of the incredible privilege and luck of being retiring so early. I’ve written before about the privileges my husband and I have–in this post as well as in my book–but it bears repeating. FIRE isn’t accessible to everyone. FIRE is fortunate. FIRE is unfair. FIRE is elite. I acknowledge all of this.
I am deeply grateful for the salaries and privileges my husband and I had because that’s what made this journey possible. No, we didn’t inherit money (nor will we) and no, our parents didn’t buy us houses or cars, but crucially, they did pay for our undergraduate education. I’ve come to view our launch into adulthood–debt-free and mostly broke–as one of the most formative elements of our FIRE journey. When we got married in 2008, we didn’t have much money, but we didn’t have any debt. Thus, everything we earned could go towards the future, not towards paying off the past. That’s a profound privilege and I am so thankful to my parents and my in-laws for that remarkable gift.
For the most part, I don’t write all that much about FIRE because I feel it occupies a niche and rare space. I prefer to discuss personal finance more generally because: a) I think that’s more useful to more people and b) frankly, I’m kind of embarrassed to admit that we’re financially independent. So while today’s post is allllll about the mortgage and the FIRE, this won’t become the focus of Frugalwoods’ work.
Rather, I’ll continue to devote a lot of space to Reader Case Studies and homestead musings and misadventures in parenting. I don’t think everyone needs to, or should, or even can work towards FIRE. It doesn’t have to be your goal. Your goal might be to get out of debt or to save up an emergency fund or start investing for your retirement and I want to be helpful to you in that process.
So please take this opportunity to let me know–in the comments–what sorts of topics you’d like to read about on Frugalwoods in the coming months. I get bored writing about myself (I mean, kinda…. ) and I want to dig into stuff that’s relevant to your life and your financial journey.