No one likes the idea of owing the bank money and being saddled with a mortgage that has a 25-year amortization period. Most homeowners dream about paying off their mortgage as quickly as possible and freeing up cash. With interest rates on the rise in Canada and with it, higher mortgage rates, the big question is, should you pay off your mortgage early or invest the money instead?
Knowing what to use your after-tax dollars on is an important question, and it’s not always obvious whether you should use extra savings to pay down your mortgage or invest for retirement.
Variables to Consider
The March 1 deadline is approaching for contributions to an RRSP, which can help reduce your annual tax bill. Knowing whether you should plan for retirement or pay down your mortgage faster has serious consequences.
Below are six variables you should consider when deciding which direction to go.
- Home’s current market value
- Mortgage interest rate
- Home appreciation in your neighbourhood
- Your income tax rate
- Expectations for inflation
- Assumed rate of investment return
When it comes to these six variables, use provincial or national averages to compare different scenarios between paying off your home early and investing. Everyone is in a different situation, so there is no right or wrong answer.
When You Should Pay Off Your Mortgage First
One of the biggest factors you need to take into consideration is determining how much you’ll pay in interest over the amortization (life) period of your mortgage. There are two parts to your mortgage, the principal and interest. The principal is the amount you borrowed from the bank and the interest is what you pay for the privilege of borrowing from a particular lender.
For example, if you buy a home for $350,000 and have a down payment of $35,000, you’ll need to secure a mortgage of $315,000. On a five-year fixed mortgage, with an amortization period of 25 years, and 5.34% interest rate, your monthly payment will be $1,894.00.
The amount you pay in interest over the life of the mortgage is $253,200; meaning the $315,000 mortgage really costs you $568,200. Or around $10,000 per year over the life of the mortgage.
Making accelerated or lump sum payments can help significantly reduce the amount you pay in interest. The less time it takes to pay off the mortgage the less you’ll pay in interest.
There are times when it might make sense to pay off your mortgage first. For example, if you’re an older, conservative investor, in a low tax bracket, and your mortgage has a high interest rate, paying off your mortgage first might be the way to go.
This scenario is in sharp contrast to someone who is an aggressive investor, in a high tax bracket, with a low, fixed mortgage interest rate. And you’re under 50 years of age. For this individual, it might make more sense to invest.
When Not to Pay Off Mortgage
There are times when you don’t want to pay off your mortgage ASAP.
- House Rich Cash Poor: In times of emergency, the last thing you want is to be house rich and cash poor. Sinking all of your money into a mortgage with the goal of paying it off early can leave you high and dry if you lose your job or are hit with some other unexpected emergency. It’s important to maintain a level of liquidity and have a cash reserve.
- Mortgage Interest is Inexpensive: A home is probably the biggest purchase you’ll make, and because the mortgage is secured by the value of the home, the interest rate is considerably cheaper than what you’d pay on credit cards and personal loans.
- Mortgage Payments Get Easier: In the early days of having a mortgage, it can be tough to meet your payments. Thanks to inflation and a growing income though, your monthly mortgage payment gets easier to make.
- Investments Outperform Interest Costs: Investments have, historically, outperformed the long-term interest costs of the mortgage. Admittedly, the stock market crash of 2008 has scared a lot of people away from investing, but it’s a good idea to diversify your holdings. For most Canadians, their only asset is their house and diversifying helps create additional wealth. Who is better off: someone who has saved $100,000 in an RRSP or TFSA, or the person with a small mortgage and no savings?
Again, some homeowners are afraid to invest their money and would rather pay off their mortgage. But historically, stocks provide higher annual returns, around eight percent; mortgage rates in Canada are hovering around 3.75%.
Low interest rates may be good for mortgage rates but it isn’t very good when it comes to saving money. Today, banks provide interest on savings accounts of just one percent. If you had one million in a savings account, you would only earn $10,000 in annual interest. You might even lose money over the long-run because of inflation. That’s going to make it difficult to retire.
To generate wealth, you may need to invest in financial vehicles like stocks. Between 1970 and 2015, the average annual return on the Toronto Stock Exchange was 10.4%. If you invest wisely, your returns should outstrip the interest you paid on that $315,000 mortgage.
Not everyone will want to invest in stocks. A conservative investors may be attracted to fixed income investments like bonds or GICs. Having a healthy RRSP or TFSA balance can help you when times are tough. Yes, you’ll pay tax on any money you withdrawal from your RRSP, but it’s better than going into debt or maybe even losing your home.
Leave Your Options Open
Most people who get their first mortgage are younger and not thinking long-term about retirement. They probably spent years trying to save up for their down payment and are just focused on making mortgage payments.
It’s important for homebuyers to have a short and long-term goal when it comes to paying down their mortgage and saving for retirement. Is it more important to pay the mortgage down fast and live debt-free or is it better to invest any extra money you have?
It’s not necessarily a bad idea to leave your options open and take your time deciding what the best use of your money is.
Canadalend.com, Helping You Pay Down Your Mortgage Quickly
If you’re a homeowner and are trying to determine if it makes more sense for you to pay down your mortgage as quickly as possible or invest any extra money, the licensed mortgage specialists at Canadalend.com can help.
Why should you choose Canadalend.com? Traditional lenders only push their own products, even if it’s not in your best interest. The experts at Canadalend.com are independent, which means they’re looking out for what’s best for you. We have access to hundreds of different lenders. Many specialize in providing mortgages to first-time homebuyers, those who have been rejected by traditional lenders, with bad credit, no credit, and unreliable income.
At Canadalend.com, we develop long-term relationships with our clients and want to ensure you’re making the financial decisions that are right for your short and long-term financial and lifestyle needs.
To find out what kind of mortgage or financial options are available to you, contact Canadalend.com today or apply online and a Canadalend.com mortgage specialist will set up an appointment at your earliest convenience.