Pay down the mortgage or invest?

Liam has a house that he’s planning to convert to a rental property. Should he pay down his mortgage or invest with his extra cash flow?

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Q: I’m 21 and I’m currently purchasing a home in Calgary for $300,000. I can afford to put roughly $1,500 away per month after all my expenses and mortgage payments. I was unsure as to whether I should attempt to pay down my mortgage (2.7%, five-year fixed) or instead invest the money and accrue roughly 6%-8% annually.

I was leaning more towards the investment route as I am young and will be using the property as a rental when I decide to leave.


A: Congratulations on your first home, Liam! That is quite the accomplishment at 21 years of age. I’ll try to touch on a number of points.

First off, I will warn you to be generous in your budgeting when you buy your first home. There are often more costs than you might otherwise suspect when you first move in, ranging from utility connection fees to repairs to furniture you didn’t realize you needed. Secondly, the ongoing costs of home ownership can be higher than expected and pop up when you least expect them–like a new furnace, an electrical issue or a broken tile.

So be lenient with your $1,500 monthly savings target. You may want to set aside some cash or ensure that you have access to a low-rate line of credit in the event of just such an emergency.

If you are a conservative investor, debt repayment with your extra cash flow may not be a bad thing, especially at a young age when you may not know exactly what the future holds. Committing to debt repayment instead of RRSPs or TFSAs at 21 is not a lifelong commitment. And avoiding interest to me is similar to earning a return on an investment, albeit a low one these days.

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If you are a moderate or aggressive investor, I would like to hope that you can “beat” the rate on your mortgage and invest at higher than the 2.7% rate you’re paying on your debt over the next 5 years. The problem, however, is that you may not know what you’re saving for, even if you think you know.

I feel a bit like I’m turning into my father here, but when I was 21, I thought I knew what my future held. After a hundred or so changes of direction, I am where I am now at 37. So the best intentions to save for retirement at 21 may turn into a stint of unemployment, three months in Brazil, an engagement ring, a wedding and so on. The point is you might not have a 50-year investment time horizon like the mutual fund companies tell you that you do–it might be considerably less, suggesting caution with your allocation to risky assets like stocks.

I would be inclined to save with only a moderate amount of risk in your TFSA with your extra cash flow – and not for the reason that you might otherwise suspect.

If you expect that you will be moving from your current home in the coming years and keeping it as a rental property, you may be better off not paying down the existing mortgage much. This is because when you convert it to a rental property, the interest will be tax-deductible. And since it’s unlikely that you’ll save enough money any time soon to buy your next house with cash and no debt, you’re going to have another mortgage anyway.

The higher your rental property mortgage – and consequently, the lower your new mortgage because you have a bigger downpayment in the first place–the more tax deductible debt and interest you will have on your tax return. The rental property interest will be tax deductible, so I’d rather see you with the least amount of non-tax deductible debt as possible on the new home.

Some people think that the tax deductibility of their debt relates to the fact that a mortgage is on their rental property and will borrow their downpayment for another home against their rental property. This won’t work, as the purpose of this incremental debt was not for the rental property itself–it is the use of funds that decides the deductibility of the interest.

TFSA savings in your 20s will provide you with a lot of options–ranging from another down payment to debt repayment if interest rates jump to RRSP contributions when your income is higher.

In summary, I think your decision to invest instead of paying down debt is ok in this instance. I also gather that you are fiscally responsible if you have purchased a home at such a young age and have bought below your means – with $1,500 in extra monthly cash flow to spare. This suggests to me that you can use your debt strategically and invest instead of paying down debt.

Just don’t fool yourself into thinking that the money you save when you’re 21 is actually going to be used to buy dentures when you’re 81. You will have a lot of other twists, turns and expenses that happen between now and then for which you may need your savings – take it from an old man like me.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

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7 comments on “Pay down the mortgage or invest?

  1. Interesting. What about if you have a 40K mortgage (no other debt) at under 3% for 20 years. Given we’re in out mid to late 50’s, I’m assuming the best plan of action is to pay down as much as we can afford on the anniversary dates to avoid paying a lot of interest over the next 20 years.


    • I agree with this article. My Wife and I are late 20’s and a year ago we converted our primary residence into a Rental property ensuring the Mortgage was as high as possible. Any extra money we had we put aside for a larger down payment on our new primary residence. Our current home we plan on raising our family in and to eventually retire in. Our 25 Year Mortgage will wrap up in our early 50’s at the same time we plan on retiring. I don’t see a point in paying our mortgage early as long as investments are outpacing interest on the mortgage. When that changes, we’ll have more money from our investments to lump sum towards the mortgage.


  2. Hi,

    I was in a very similar situation as Liam, except now I am 27-year-old and have a 4-month old baby. We have a townhouse in Coquitlam BC, and I have been diligently paying off the mortgage for the past several years (2.7%, five-year fixed, term ends 2018). I am planning to pay off the entire mortgage at the end of the term, however, with the record-low interest rate, perhaps it makes more sense to invest the additional savings into other market and “expecting” a higher return.

    Like the author mentioned, at this stage of our life, we probably still have many uncertainties, hence we should ensure our assets are somewhat liquid enough for any unexpected events. Besides the additional mortgage payments, I am trying to put as much saving as possible into my TFSA, and have them parked in stocks or mutual funds. However, these types of investment come with some significant risks, especially with the way the market is trending.
    Once the mortgage is fully paid off, since the rate of return for renting out the townhouse doesn’t make any financial sense, we’re planning to “trade it in” for upgrading to a bigger home.

    My biggest dilemma for this type of situation is “what to invest in?” Ideally, you wanted to invest into something has a return greater than the interest rate (2.7%), and has a low-risk/volatility, since you want to able to convert these investments into cash in a short-term. Right now, I am having trouble building a portfolio that is actually better than paying off the mortgage, which essentially translates to a 2.7% return at zero risk. I guess it comes down to a person’s risk tolerance, which could vary depends on your personal situation.


  3. Great response Jason. We had a very similar situation years ago except we opted to pay down the mortgage (primarily due to a lack of knowledge about investing at the time). It definitely stings to not be able to deduct mortgage interest via the rental as well as see the markets grow beyond what the interest rate is on the mortgage. If I could go back to my younger self I would have followed your advice as well. I’m glad you’re helping out young Canadians like Liam. Take care.


  4. It would be interesting to know how he is plans to earn a 6-8 percent return in today’s environment !!!!!!!


    • Buy a bank stock easy 6-8% return


  5. “the best of intentions may run into a stint of unemployment, 3 months in Brazil and a wedding ring.” good one Jasin. truer words were never spoken!


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