# Make 12% to 60% tax-free from your mortgage

We are working hard to paying down debt. We recently started paying off our second mortgage. I started thinking, how much does a mortgage cost you?

Here’s an example. Let’s say we have a second mortgage of \$60,000. The interest rate is 5%, and you are paying monthly for the next 15 years. If you pay at the beginning of the month, the monthly payment is \$472.51, using the PMT function in Excel. \$472.51 multiplied by 180 months gives us a total of \$85,051.80. If we subtract our principal of \$60,000, the interest is \$25,051.80. Sure, that seems reasonable over 15 years. That’s about \$1,670 in interest a year.

\$25,051.80 divided by \$60,000 gives us 41.753%. When you sign the mortgage papers, the funding documents will mention how much interest you have to pay over the life of the loan. This interest is unevenly spread over the next 15 years, with your first mortgage payment containing more interest, and your last mortgage payment containing less interest. Blame the actuaries. That’s how the math works. Your first mortgage payment you pay \$246.57 in interest. Your last mortgage payment you pay \$3.68 in interest. That’s a large difference.

If we divided our first interest amount of \$246.57 divided by our first payment of \$472.51, we paid out 52.2% or our payment as interest. Through the first year, we are paying more than 50% in interest per payment. Through the 13th year, our interest as a portion of our payments stays above 12%. If we could accelerate our payments, we would save this interest expense. Interest expense is what I call a virtual expense. The expense is real when you pay it, but if you pay it ahead of time, the expense seems to disappears. You only know it existed in comparison to something else.

I have discussed how our goal is to make more than 12% a year, after taxes, on our investments. Paying down debt is an investment in yourself. Once you clear the debt, the payment you were making to the bank and the bank executives gets paid to you. It’s tax-free, you are already paying taxes on the income. For most of us, a tax free return of more than 12% sounds great. We can use the money we save to upgrade the house, help the kids with college, go on a vacation, donate to charities or good causes, create an emergency fund, invest the money, get a pet or save for retirement.

How do things look like if you have a primary mortgage? The current limit for a Fannie Mae or Freddie Mac primary mortgage is \$548,250 in 2021. Financial institutions will buy your mortgage and sell it to Fannie Mae or Freddie Mac and repeat the process. The lowest rate I see on bankrate.com is 2.875% for a 30 year mortgage. This gives us a payment of \$2,204 with a 10% down payment. Let’s repeat the exercise we did for our second mortgage.

If we take \$2,204 in monthly payments, and multiply it by 360 months, we get a total cost of the primary mortgage of \$793,440. After subtracting how much we owe for the house, \$493,425, that gives us an interest paid of \$300,015. The total interest of \$300,015 divided by our loan of \$493,425 is 60.8%. That means 60.8% of our loan amount is given to the bank as interest. For the first few years, every extra dollar we send to the mortgage servicer, we are saving more than 60.8% in interest. That’s a hell of a return, tax free.

For most of us outside the top 1% of people, \$300,000 is a lot of money. Combine that with the payments you save and invest. It can be many years of our combined income while we are working. How would an extra \$300,000 change your life? How would an extra \$150,000 change your life? For me, I know I would be under less stress. We could probably shift from two incomes to one income. My wife and I might even be able to retire sooner and have the freedom to do what we want faster.

We can say simply, the more money we owe, the higher interest rates we have to pay, and the longer we owe the money, the higher we will pay in lifetime interest. We should want to get out of debt as fast as we can and reduce lifetime interest. It’s in the bank’s profits to keep us in debt as long as we can. This is why banks and insurance companies have the largest buildings in downtown urban areas. They know how compound interest works. Their executives are well paid. Why not pay yourself first and be your own executive? Always buy the cheapest house that meets your needs. Learn from our mistake. Mortgages are expensive. Freedom is priceless.