Thursday, March 24, 2011

Money Management Part Eight - Free and Clear

January 2015.  Jack and Jill now have kids who are six and eight years old.  In the last five years they have paid off all their consumer debt, their car and Jack's student loan.  They have established a $1,000 emergency fund in the bank and have over $18,000 in a money market fund that they can access in case of a financial or family crisis.  They have started investing for their retirement and for their kids' education.  Jill is still doing some bookkeeping work from home, bringing in about $500 per month.  And Jack's career is doing well.  He just received a promotion and with it a small raise that brings his income to $67,000 per year, or $5583.33 per month.  He and Jill are discussing what they should do with this extra money.   Jack suggests calling Richard and Jane to come over for a visit.  They've just returned from spending three months on a third-world missions trip, and the friends have been meaning to get together anyway.

"Hey, Richard!"  Jack greets his friend.  "How are things going?"

"Fine, fine, thanks for asking.  And you guys?  How's life treating you?"

"Great!  I just landed a promotion, in fact.  Jill and I were just discussing what we should do with the extra income, and of course your name came up."

"Well, you've been at this for a while now.  What do you think you should do with it?"

"There are a couple of options.  The car is coming on what, seven years old now.  It's soon going to need to be replaced.  We could increase our investing.  We could use it to pay for sports for the kids..."

"Can I make a suggestion?"

"Please do!"

"Throw it at your mortgage.  That's the last thing holding you back from real financial freedom.  You've taken care of everything else - now it's time to take on the dragon.  How much of a raise are you talking about here?"

"$483.33 per month."

"That will make a nice dent.  Remember that spreadsheet we were using for your debt snowball?  Get that out and start punching in numbers, and see if you don't find some motivation."

They chatted a bit longer, than Jack went to find Jill and the spreadsheet.  They sat down together and started filling in numbers, playing out 'what-if' scenarios and coming up with some interesting results.  When Richard and Jane arrived, they jumped right in.

"If we put this whole raise onto your mortgage, and you just continue as you've been...." Richard looked up.  "What other sources of income would you consider throwing against this?"

"Income tax refunds seem like an obvious choice,"  Jack replied.  "I know a lot of my co-workers use that money for RRSPs, but at the rate we're already investing, I'm happier to use it to get us closer to financial freedom."

"Sounds good to me, too."  Richard nodded, filled in some numbers, then brought out his computer.  Now let's take a look at this.  Right now, continuing your mortgage payment according to your contract, you'll have it paid off in April 2035.  And you'll pay a total of $111,849.18 in interest."

"Ouch - that's practically paying for the house twice!"  Jill was surprised.

"Don't I know it," Richard agreed.  "'But let's start doing the math.  We'll assume a $4,000 tax refund each April, plus another $5799.96 each year from Jack's new raise.  That's $9,799.96 paid in a lump on your mortgage each April.  Depending on the terms of your mortgage, you might be able to make extra payments more often, but we'll assume right now that you can only do so once a year."  He put the numbers into the computer.  "Now, take a look at this!"

"Unreal!"  Jack blurted out, amazed.  "We just saved... is that right?  Over $50,000 in interest?"

"Yup.  Not to mention cutting thirteen years off your mortgage.  By this plan, you'll have your house paid off in 2022 - just seven years from now, instead of twenty.  That's harnessing the power of compound interest and putting it to work for you instead of against you.  By steadily reducing the balance, you are slowly and steadily reducing the amount of interest that is accumulating.  You can make this even better if you invest that $483.33 every month in something that will earn you interest, then withdraw the balance in April to pay it onto your mortgage each year.  Every dollar counts!"

"Niiiiiice."  Jack looked thoughtful.  "I wonder what else we could do with this?"

"And what we could do after this!" Jill exclaimed.  "That would free up another $827.00 each month that we could use to crank up the kids' college accounts, to buy a vehicle..."

"Or to be more generous than you've ever been able to be in your life!"  Jane cut in.  "That's the final step on this journey - once you are no longer a slave to debt, and you become master of your money, then you can do the things you've never been able to do before.  Cut your work hours and spend time volunteering.  Make donations to charity that you've always wished you could.  Go on a missions trip.  Adopt sponsored children.  The sky is the limit!"  It was obvious how passionate Jane was, and how much she loved their new, debt-free life.  They still lived simply by some standards, but they had everything they needed, some of what they wanted, and they were free from the stresses that held so many of their friends back from living fully.

"You know what, I think I finally get it," Jack said thoughtfully.  "I had wondered so often what it was that was different about you guys. You always seem so... content.  This is it, isn't it?  You found freedom."
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