How can I pay off my mortgage faster?

This is a question you will inevitably confront in pursuit of your own financial security. Your first intuitive response is to get out of debt as soon as possible. In our minds, the concept of making monthly payments for an extended period of time is antithetical to freedom. Therefore, we seek to liberate ourselves as quickly as possbile.

Let’s explore how you can achieve this…

How To Pay Off Mortage Faster

If you take the decision to pay off your mortgage early, all you’ll need to do is pay more principal. Paying mortgage principal early is a powerful money save as small debt reductions compound dramatically over the tenure of the loan. Thus, eliminating many times the payment in interest.

How Much Can You Save by Paying Off Your Mortgage Early?

Mortgage Assumption: 25-year loan, fixed rate, fully amortizing, Ksh 10,000,000 mortgage at 12% creating monthly payment of Ksh 105,322.

Let’s consider a 25-year mortgage, Ksh 10,000,000 at 12% has a monthly repayment of 105,322, with only Ksh 33,333.33 going to the principal in the first month.

If you add just an additional Ksh 10,000 to the monthly payment, you will literally double the principal paid in the beginning to eliminate 70 payments over the life of the mortgage, save Ksh 6,000,820 in interest costs, and shorten the payoff time from 30 years to 25 years to 19 years.

Let’s visualize it…

Not bad for an extra Ksh 10,000 per month…

Strategies for Early Repayment

If these numbers sound appealing to you, there are various strategies you can deploy for early mortgage payoff. Starting from the simplest, moving to the most complex:

1. Adding Pinicipal to Your Current Monthly Payment

If your mortgage doesn’t have an early prepayment penalty, the simplest early payoff strategy is to simply add a principal to monthly payments. You can pay a one-time lump sum (perhaps proceeds from selling an asset) or just add a little extra monthly (proceeds from a raise or bonus). The concept is to use money that you can live without and won’t miss if you used it to pay down your principal.

2. Biweekly Payment Schedule

If you can, rather than make one mortgage payment per month, try making half the payment every two weeks. Since there are 52 weeks in 12 months, you’ll make 26 half-payments or 13 full payments instead of the usual 12 – one extra payment per year. Depending on your own individual situation, this can significantly cut up the life of your loan by 9 years.

3. Refinance to Lower Interest Rate

Consider refinancing your mortgage to a lower interest rate while keeping the term of the loan the same. The key is to not take any money out or extend the term when you refinance. Therefore, the new loan will offer a lower payment due to reduced interest costs. So when you continue making the same payments as before, all the extra will go to the payoff principal. The best thing about this strategy is that it doesn’t require any additional money to achieve your desired results.

4. Refinance to a Short Term

Rather than pay your mortgage over a 25-year amortization, try reducing the term to 12.5-years or make payments as if it were a 12.5-year loan amortization. The monthly payments will be higher, but the interest rate will usually be lower. Thus offsetting the total payment towards the loan. People tend to prefer this variation due to its increased flexibility and reduced cost, while others prefer the enforced discipline of the requirement for monthly payment.

5. Downsize to a Lower-Cost Home

Changing homes isn’t an option for many, but it must be mentioned here. You can consider moving to a lower-cost area or buying a smaller house in the same area. The smaller mortgage principal means you can be debt free faster using the same monthly payments you’ve been making.

Pay Off Mortgage Early – The Pros…

Now that you know the various strategies to pay off your mortgage early, let’s take a look at the benefits:

Let’s look at the benefits of paying off your mortgage early.

1. Save Money. Paying off your mortgage early can save you a lot of money in interest costs.
2. Peace of Mind. Freedom from debt and the security of having your own place to live is the best feeling ever.
3. Reduced Cost of Living. For most people, mortgages constitute their biggest expense after taxes. Thus, without a mortgage payment, you can save more, work less or spend on other things you’ve always wanted but couldn’t afford before.
4. Get Rid of Private Mortgage Insurance. When you accelerate paying down the principle, your home equity will reach a threshold where private mortgage insurance will no longer be required. Therefore, saving you money long before you have fully paid off your loan, allows you to accelerate even more your principal repayment while still making the same monthly payments.
5. Retirement Planning. Owning a home as you near retirement, rather than putting your money in fluctuating investments.
6. Guaranteed Return on Investment. It is quite comforting to put your money towards your own home and know with certainty what the return on investment will be.
7. It’s Achievable. Many consider paying off their mortgage as a more tangible concrete financial goal, which can be quite motivating. It is big enough to be excited about and can make a significant difference in one’s life.

Related: The Most Affordable Mortgage Rates and Top Providers in Kenya

Pay Off Mortgage Early – The Cons…

Paying off your mortgage early may seem like a slam-dunk decision at first, but there are some downsides to it. Let’s review them.

1. Lose the Tax Deductibles. The mortgage interest paid is generally dedicated to your tax return, ergo decreasing the cost. In Kenya, mortgage interest expenses are deductible up to Ksh 300,000 or Ksh 25,000 per month.
2. Low Return on Investment. A home mortgage is likely the cheapest you will ever borrow – and the interest deductibles, further decrease the effective cost.
3. Savings are in Cheap Kenyan Shilling. A key point to consider here. All the savings expect only come after the mortgage is paid off, meaning those savings must be discounted for inflation. Let’s say you repay your 25-year mortgage in 19 years. If you save Ksh 6M in a 19-year tenure, you will see that Ksh 6M is only worth Ksh 1.7M in today’s terms at a 6.75% inflation rate. In order words, you need to discount all savings by inflation because the payments you avoid will be in depreciated Kenyan Shillings.
4. False Sense of Security. Even though you property is full paid for, you do not fully own it. You still have to pay land tax annually to the local government. In other words, you still have to pay some form or rent whether or not the bank is out of the picture. The truth is, true mortagage freedom is an illusion – your monthly payments are merely a question of degree and to whom – not whether it exists or not.
5. Lost Diversification. Most investor portofios are denominated in domestic currency and thus carry the risk of inflationary government policies that depreciate an investments purchasing power over time. Therefore, a resdiential real estate mortahe is the only practical way for most people to short their domestic currency and hegde against inflationay economcic policies like the ones were are facing today.
6. Interest Rate Below Expected Inflation. There are record low mortage interest rates as of this writing, its entirely possible that the interest rate on a fixed mortage could turn out to be lower than the inflation rate. If this is the case, then you are literally being paid to borrow money in real terms even though you are paying itnerest every month. Thus, you make more by owing than by owning. When you pay your mortgage early under these circumstances, you give away that financial advantage.

Read More: 9 Reasons Real Estate Investing Is The Way To Go

Final Thoughts

The decision to payoff your mortgage maybe intutively and logically right in the moment. There is a lot that needs to be considered as there are moments when that intuition and finance disagree. The truth is the decision to pay off your mortgage is quite complex. There is some to be gained and some to be lost. Therefore, like everything in life as you employ any of these strategies, try to find some balance of those gains and losses.

Image credits: Top by Tima Miroshnichenko via Pexels.

Those before us meant well to us when they left behind these money tips. But, in this day and age, though meaningful to some, they are outdated and do not apply to the times. Millennials and Gen Zers, know all too well because experience is the best teacher.

We are facing different economic problems from the past generations – more so for Gen Z, than the Millenials. Some of these problems are unprecedented. For instance, personal finance tips in the past seemed to cater more to men, than women. We also live in a time of high technological advancement, rapid economic expansion, high population growth, and dependency and climate change.

Therefore, here are five outdated pieces of financial advice, that most millennials and Gen Zers would rather turn a deaf ear to.

1. Time is Money

Time is time and money is money. We do need time to make money but money in itself is limitless while time is merely equal to existence – not the money in the bank.

Time is Money is an aphorism by Benjamin Franklin that is claimed to have originated from his essay “Advice to a Young Tradesman”. During his time, a person of trade traded his time for the money he earned. Today, people still think we do the same. However, we live in unprecedented times of rapid growth and expansion precipitated by technology. Technology has allowed us to leverage our time, and earn a limitless amount of money. Though this aphorism may have contained some general truth back then. This isn’t the case today.

2. Start A Side Hustle or Get A Second Job

The cost of living today is exponentially higher for millennials and Gen Zers. Getting a second job or side hustle won’t fix the larger systematic economic problems they face.

When their parents were younger, land or education was not so expensive. But now, how many side hustles do you need to purchase land in Nairobi for instance?

Therefore, getting a second job or starting a side hustle falls on deaf ears for many young people. They are simply just fed up with how expensive life generally is. It’s becoming harder and harder to do the same things their parents did when they were young.

3. Stop Eating Out to Save Money

What is the dream of every young Kenyan? This is a question I have always asked myself. What would be the life we dream of? Is it a life of affluence like our politicians, and celebrities portray?

Since forever, millennials and Gen Zers have always been told to work their ass off. And, if they get it right, they can live well. So they worked hard, got into college, and graduated swimmingly…only to face the harsh realities of our job market.

In this rat race, there is a moment of rest. The older generations continue double down on this advice. In reality, the income from your job isn’t even close to being enough and a side hustle won’t solve it. Therefore, millennials and Gen Zers still prefer to keep it realistic. They set aside some money to spend time with friends and enjoy life. It’s too short after all.

3. Stay Loyal to Your Full-Time Job

Millennials and Gen Zers, are known to hop from one job to the next. Always demanding more pay, more benefits, and better treatment. They are not conservative as older generations. Being loyal doesn’t pay. And if you stay in one place too long, you lose a lot of money because your employer knows you will not leave.

Millennials and Gen Zers know that you can only save as much as you earn. As such, you can always increase what you earn to increase how much you save.

4. All Debt is Bad

Younger generations are often strapped down by student loan debt. Therefore, most are forced to normalize the idea of debt earlier on. While older generations are looking to repay their debt immediately or avoid it altogether, Millennials and Gen Zers are looking to take on more debt. This is because they understand it’s beneficial to building the life they want.

Debt may have a bad reputation as some people deem it morally bad. We tend to refer to debt as debt when the poor take it on, while for the rich it’s called leverage. Debt is what you make it out to be – neither morally bad nor good. Just like an investment account or a savings account, debt is a tool. And, the younger generation now more than ever needs to learn how to properly utilize it.

Learn more: Flat Interest Rate vs Reducing Balance Rate, Which One Saves You Money?

5. The 30% Rule

Have you ever heard of the personal finance gospel of the 30% rule?

It says that you should budget 30% of your gross monthly income for housing costs. It is a great rule but might be hard to strictly stick by. Consider how different life choices are among Millennials and Gen Zers.

If you earn a six-figure income and you live in a low-cost area, there is no need to spend so much. And, if you love living in a big city and decide that you do not need a car, you can afford to spend much more on housing. Therefore, all that matters is that you are making strides toward your financial goals. If you are saving, paying off debt, and investing, then the amount you spend on housing is irrelevant.

In A Nutshell

Millennials and Gen Zers would rather turn a deaf ear to advice with regard to eating out, debt, rent, side hustles, and more. The times have changed, and we must change with the times. What may have worked with our parents, isn’t working now. The cost of living is exponentially high, while wages largely stay the same in most jurisdictions.

Image credits: Top by Nappy via Pexels

When shopping for a loan, one of the key factors to consider is the interest rate. Some financial institutions will offer you a “Flat Interest Rate” and others, a “Reducing Balance Rate” or both when applying for a loan. These two options as you will come to understand, are relatively simple to understand. Do not solely rely on the bank to do all the calculations for you. Or allow them to drive you to make a decision that doesn’t serve you.

That said, it’s best to stay informed on these financial terms. Here’s our explanation of what flat interest rates and reducing the balance interest rate are, their calculations and their differences, made simple to help you manage your own finances.

Related: How to Manage Debt Better

What is a Flat Interest Rate?

A flat interest rate is an unchanging interest rate charged on liability i.e a loan or mortgage. The interest rate and the amount payable remain constant throughout the duration of the loan and thus overlook the fact that the equated monthly instalments lower the principal amount. Thus, over the tenure of the loan, the interest rate is consistently estimated based on the entire principal amount.

This is how it is determined.

How to Calculate the Flat Interest Rate

It is relatively simple to calculate flat rate interest costs for a loan. You will need the following:

• The loan amount i.e. principal
• The interest rate per annum
• The loan repayment period i.e. number of years or loan tenure

Formula:

Interest Instalment =(Principal x interest rate per annum x number of years)/number of instalments

Let’s apply.

For example, let’s assume that you take to a Personal Loan for Ksh 1,000,000 for a period of 5 years (60 months, which translates to 60 instalments for that period) at a flat rate of 12% per annum.

You must pay –

Interest payable per instalment = Ksh 1,000,000 (principal) * 12% (flat interest per annum) * 5 (no. of years) / 60 (no. of instalments) = Ksh 10,000 per month in interest instalments.

This means that after adding your principal components (principle/number of instalments), your equated monthly instalment would be Ksh 26,666.67 per month. Therefore, during the entire duration of your loan, you will pay a total of Ks 1,600,000.

Benefits of Flat Interest Rate

Easy Calculation

The flat rate interest method makes calculations simple. It allows for greater transparency in loan agreements. Both the lender and the borrower can easily calculate the rate with ease. The calculations are made even simpler due to the equated monthly instalments. This is particularly so when calculating the long-term cost of borrowing. With a few bits of information (loan amount, interest rate and loan repayment period), anyone can easily and accurately calculate.

Predictability

Using the flat rate method you can effectively plan your monthly finances because the equated monthly instalment does not change from month to month. By doing so, flat rate interest provides hustle-free planning and payment.

Lower Rates

In general, flat interest rates are more attractive when interest rates are lower. Therefore, typically employed more on lower interest rates than reducing balance rates.

What is Reducing Balance Interest Rate?

A reducing balance interest rate is an interest rate that is determined monthly based on the amount of the outstanding loan balance. As such, only the amount of the outstanding loan is used to determine the interest for the subsequent month.

The equal monthly instalment for a reducing balance loan includes both the principal repayment and the payable interest on the outstanding loan balance. Where the payments lower the amount of the loan that is still due.

It is relatively simple to calculate flat rate interest costs for a loan. You will need the following:

How to Calculate the Reducing Balance Interest Rate

To calculate the reducing balance interest rate on a loan, you will need the following:

• The outstanding balance i.e. remaining loan amount
• Interest rate

Formula:

Interest payable/instalment = Remaining loan amount * Interest rate per instalment  

Let’s apply.

Suppose a case where you take out a Ksh 1,000,000 loan for 5 years at 12% per annum, reducing the balance rate. The monthly equated monthly instalment (EMI) is Ksh 22,244.45. This EMI consists of a percentage of the principal amount that is to be repaid as well as an interest component.

Now, in the first month, 12% is charged on Ks 1,000,000 principal amount. Out of the total EMI of Ksh 22,244.45, the first month’s interest component in the monthly instalment is $10,191.78. The remaining Ksh 12,052.67 goes towards the repayment of the principal. Therefore, at the end of the first month, the remaining balance becomes Ksh 987,947.33 (Ksh 1,000,000 – Ksh 12,052.67)

In the second month, 12% is charged on a reduced balance of Ksh 987,947.33. The interest of the EMI becomes Ksh 9,094.53. The remaining Ksh 13,149.92 goes towards the repayment of the principal amount. This continues in the following months until the repayment of the loan is fully completed.

Benefits of Reducing Balance Rate

Over time, the interest paid is less compared to loans with flat interest rates. This is because interest is only calculated based on the outstanding loan amount. Additionally, a loan with a decreasing interest rate though might have a longer tenure, but it gives greater repayment flexibility.

Difference between Flat Interest Rate and Reducing Balance Interest Rate:

• In the flat interest rate, the loan’s principal amount is used to calculate the interest rate. While as with the reducing balance rate method, the outstanding loan balance is used as a base to calculate interest each month.
• The repayment liability remains fixed with the flat interest rate, while with the reducing balance it keeps varying.
• Interest calculations using the flat interest rate method result in higher equated monthly instalments, while as the reducing balance interest rate results in diminishing interest over time as repayment instalments are made.
• The flat interest rates are typically lower than reducing balance rates.
• Calculating the reducing balance rates is more difficult than calculating the flat interest rate, which is quite straightforward.
• Overall, when comparing the two, the reducing balance rate is a better alternative.

FAQs

How interest rates are determined?

The Central Bank of Kenya (CBK) sets the repo rate, which is the rate at which commercial banks borrow from CBK. Based on this rate, banks issue their lending rates.

How can I know my EMI before taking any loan?

Before taking any loan, know your equated monthly instalments (EMI). It is advisable that you completely understand your amortisation schedule for your loan. Consider your loan amount, intended tenure and interest rate offered. For ease of calculations, consider using a free online EMI calculator.

Flat interest rate or reducing balance method, which is better?

The decision on which is better is subjective. The decision on which is better should be based on your personal financial requirements and repayment capacity. Overall, you will end up paying less interest under the reducing balance method. But with the late interest rate loan, the tenure is shorter as you will end up repaying the loan faster.

Related: Reducing Balance vs. Simple Interest Loans – Which is Better?

Wrapping up: Which One Saves You Money?

Though flat interest rates are easy to understand, easy to calculate and often offer lower interest rates, they may not be as advantageous. The Reducing balance interest rate will save you money overall. When offered both options by your service provider, it is always wise to add all the interest payable during the duration. This is the best method for comparing the true cost of a loan.

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The sustained, broad and quick rise in prices of goods and services, is seriously eroding purchasing power. A nation’s goal is to maintain a small but positive inflation rate that is economically useful. High inflation impairs long-term economic performance, as it tends to feed on itself. This phenomenon reminds me of the Ouroboros, which is often used as a metaphor for the financial alchemy driving the bear market in fear. Because, as consumers spend more and save less due to high inflation, the velocity of money increases in the market further boosting inflation and contributing to inflationary phycology.

Consider, what inflation is. Inflation measures the rate at which the purchasing power of money erodes over time. As money acts as a store of value, money’s purchasing power is wholly dependent on price levels. Therefore, as prices increase, each unit of money becomes increasingly less valuable – eroding its purchasing power.

How Inflation Affects Asset Values

Assets with fixed, long-term cash flows tend to perform poorly when inflation is rising, since the purchasing power of those future cashflows falls over time. Conversely, commodities and assets with adjustable cashflows (eg. property rental income), tend to perform better with rising inflation and are often used as an inflation hedge. Let’s take an in-depth look at the effects of inflation per these loosely categorised asset classes.

A. Impact of Inflation on Share Prices

The relation between inflation and share price is quite complex on an ordinary day. Recent economic times have been heavily muddied by recently past performance since the onset of the pandemic. Keep in mind that the NSE has been named the third worst-performing stock market on the continent since January. And, if you hold shares, you’ve most definitely felt a bearish trend. The flight of foreign investors and ease of repatriation in the recent past have resulted in the continued fall in stock prices.

However, this cannot be compared to the effect inflation may have on the share price on the stock exchange. So, let’s take a look at the long-term and short-term perspectives of the impact of inflation on stock prices.

Inflation and Stocks in the Short Run

Short-run dynamics are the least favourable as the relationship between equity prices and inflation will have a negative correlation. As inflation rises, stock prices fall and vice versa. This adverse effect of inflation on stock prices in the short term could result from a range of factors such as falling short-term revenue, general economic slowdown and/or lowered or even negative returns decreasing demand for equity investments.

Inflation and Stocks in the Long Run

The current inflation rates, despite government indicators, have become so high eroding purchasing power

So will inflation hurt stock returns in the long run? The current state of the economy may have you considering changing your investment strategy.

Learn more: 7 Timeless Ways to Protect Your Finances Against Inflation

B. Impact of Inflation on Debt Securities

Inflation is very damaging to fixed-rate debt securities as it devalues the interest rate payments and principal repayments. If inflation exceeds the interest rate, investors are in effect losing money after adjusting for inflation. Therefore, as an investor you should:

• Focus on the real interest rate which is derived by subtracting the inflation rate from the money interest rate.
• Ensure that your fixed income portfolio is built for rising rates. Long-term fixed-rate debt is more vulnerable to inflation than short-term debt because the effect of inflation on the value of repayments is correspondingly greater, and compounds over time.
• Seek to invest in assets that perform best under inflation. Go for investments that bring in more cash during times of rising inflation or rise in value as inflation increases.

C. Impact of Inflation on Real Estate

Although real estate continues to be a popular choice as a store of value amid inflation, it isn’t completely infallible to rising interest rates and financial crises. Keep in mind that the increase of interest rates is a conventional monetary policy response to rising inflation. So who knows how far our current state of inflation will last? And, how changing monetary policy will move our economy?

This, however, doesn’t completely take away from the merits of investing in real estate. It is still a great store of value while still generating increased rental income amid inflation. So, investors have the choice to either purchase real estate directly or invest in it by buying shares of a real estate investment trust (REIT).

Learn more: How to Profit With Real Estate Regardless of The Economy

D. Impact of Inflation on Commodities

Whenever there is a rise in inflation, investors tend to turn to tangible assets that are likely to rise in value. For centuries, investors have turned to gold and other precious metals – causing the price to rise as inflation rises. Other commodities that have been considered include oil, copper, wheat, cotton and more – which tend to rise in inflationary environments.

If you’d like to purchase gold, you can get it directly from a bullion or con dealer or indirectly by investing in a mutual find or exchange-traded fund (EFT) that owns gold. In Kenya, we have the option to purchase the Absa New Gold ETF. The Absa New Gold ETF has been trading at an all-time high.

Sophisticated investors also have the option to trade commodities futures or the shares of producers, in advanced markets.

How Inflation Affects Savings

The high inflation rates we are currently experiencing are quickly eroding the value of your savings faster than ever.

Let’s say you have Ksh. 100,000 in a savings account that pays a 5% interest rate. After a year, you will have Ksh. 105,000 in your account. But if the rate of inflation is running at 7%, you would need Ksh. 107,000 to have the same buying power that you started with. Therefore, as much as you have gained, you are losing buying power at the same time. So, anytime your savings do not grow at the same rate as inflation, you will effectively lose money.

The overall quick rise in prices today is reducing the purchasing power of consumers, since a fixed amount of money will afford progressively less consumption now, and even less in the future.

So how can you assess the impact of inflation on your savings?

The Rule of 72

A simple way to measure the long-term effects of inflation on your savings is the “rule of 72”. Typically, we use this rule to approximate how many years it will take an investor to double their money at a certain interest rate.

Here’s how it works: Divide 72 by the annual interest rate to determine the amount of time it takes for an investment to double.

For example, money invested in a mutual fund yielding 10% a year would double in a little over 7 years, according to the rule. One with a 7% annual return would do so in approximately 10 years.

How to Plan Ahead

Despite the persistent increase in the cost of goods, we can always take assurance that our government will at least make efforts to keep inflation in check. As investors, we need to avoid panicking and avoid emotion-based decision-making. Rather, look to preserve portfolio worth from the effects of rising inflation and preserve your buying power. And, diversify your holdings. Hedge for inflation and replace equity exposure with strong assets that can weather any economic storms with ease. For instance, consider businesses with less reliance on raw materials or interest-rate-sensitive stocks. Any rise in costs or interest rates will increase operating costs for the company.

Image Credits: Top by Anna Nekrashevich