Oct072009

How quickly can you pay off your home loan?

The Time-to-Payoff is the amount of time it takes to retire the debt used to acquire the asset (house). It is a handy tool of those who use Accelerated Amortization.debt_is_wealth

When people examine investments, they often look at rates of return to compare between asset classes. Rates of return are a valuable metric. When thinking about retirement finance, rates of return become less important than steady cashflow. We need a new measure of success for reaching your retirement goals: Time to Payoff.

Today, I want to look at another feature of cashflow investing: debt retirement. In Real Estate, Cashflow Investment and Retirement I noted, “… you can take the excess rent and put it toward the mortgage paying off the debt more quickly. Remember, the goal is to have maximum free cashflow in retirement, so you want to pay off those debts.” Retiring debt is part of the cashflow investment mindset; it is diametrically opposed to speculation.

Paying off debt is as difficult as dieting — there is always a temptation — whether it be spending or eating. The success rates for debt retirement are no better than they are for weight loss. Perhaps we should have a TV Show for the Biggest Saver.

Calculating Time-to-Payoff is a challenge. It requires looking at the available sources of cashflow and the impact the property has on its owner. There is a level of cashflow that can be diverted toward debt service that otherwise does not impact the owner’s life.

For example, if a property is about $600 per month cashflow positive before debt or taxes, the debt service payments can actually be closer to $900 per month before the owner is truly cashflow negative. How can this be? Isn’t paying out $300 a month more in payments making you cashflow negative? Not really. Part of that payment is equity that is paying down debt, so that is not a true expense. The interest will be tax deductible for most wage earners, so the owner can adjust paycheck withholdings to compensate for the difference in payment. In short, the property has no net financial impact on the owner.

If the property is cashflow positive — which it must be for this analysis to work — there will be money that can be put toward debt service. If the maximum available cashflow is put toward debt service, how quickly does the loan amortize? That is Time to Payoff.

If you invest in the Time-to-Payoff way, your property investments will have no impact on your financial life — plus or minus — until you retire. There is no demand on your income to service the investment, and there is no net benefit for you to spend on your lifestyle. Let’s just say, it isn’t a lifestyle alternative many people were choosing during The Great Housing Bubble.