Got extra cash? Your mortgage can wait

Becoming debt-free is one of the best feelings in the world. Here are a few reasons you might want to delay that gratification

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From the December 2015 issue of the magazine.

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Who doesn’t crave the financial freedom that comes with having no debt? In the perennial debate over what to do with some extra cash—throw it at your mortgage or invest it and save for your future—the MoneySense position has always been the pragmatic, conservative and responsible one: Pay off your home, then use the surplus cash to double down on your retirement savings.

It’s a one-size-fits-all strategy. And no question, being mortgage-free feels great. The problem is this advice dates back a decade or more, when mortgage rates were dropping from the double digits and investors could bank on a steady 3% to 5% return from GICs alone. Times change—and so does money advice. So I’m about to make a suggestion that’s akin to financial heresy: Don’t bother paying down your mortgage. Use the money to invest. You’ll come out ahead in the long run.

Risk is smart.

No one would argue that paying off your mortgage faster isn’t a sound investment. This strategy translates to a risk-free, after-tax return of between 2% and 3%—or whatever your negotiated mortgage rate happens to be. That’s certainly more than you’d earn with any other risk-free investment out there, such as a GIC or savings account. But for many homeowners, it also means leaving money on the table.

“The decision to pay down debt, at the expense of retirement savings, is often an emotional one that isn’t driven by the numbers,” explains Jamie Golombek, managing director for Tax & Estate Planning at CIBC.

What do the numbers say?

Over the last 50 years, the prime lending rate has hovered around 8%; the average annualized return for the TSX over the same period was 9.5%. Consider that if you were to pay an extra $1,000 a month against a $350,000 mortgage; you could be debt-free in less than eight years and save almost $98,000 in interest payments. But invest that money in a balanced portfolio with a conservative annualized return of 5% and, over the same period, you would have saved more than $154,000. It’s a simplified example, for sure, but the point is that without risk you could end up flipping hamburgers in retirement—wishing you’d saved more.

A new normal.

You might ask: What happens when rates rise? While analysts from RBC Economics, Morgan Stanley and the C.D. Howe Institute expect rates to rise in 2016, they don’t anticipate a return to the “normal” prime rates of 5% or 6% anytime soon.

There are a few reasons for this. Aging baby boomers are leaving the workforce, which puts downward pressure on the nation’s labour market, which in turn lowers productivity growth, limits the economy and suppresses inflation. Also, America’s recovery from the 2008 credit crisis has been slower than expected. And the dramatic decline in oil prices has yet to show signs of reversing. Regardless of the reason, rates are predicted to remain low—at least for the next half a decade, maybe longer—and this is an opportunity to take advantage of that.

More eggs, more baskets.

Let’s say you’re a safe, conservative investor with 20 years ahead of you before you retire and no desire to chase returns. Should you concentrate on eliminating that mortgage debt?

No. The reason boils down to a basic building block of sound financial planning: diversification. By paying off your mortgage first you may become debt-free, but the bulk of your net worth will be tied to just one asset—your house. If your neighbourhood real estate market tanks, those anticipated savings would drop. Worse, if sales stall, you might not be able to access your equity or be forced to accept less. Just ask Calgary homeowners, who suffered a 32% drop in housing sales earlier this year.

The choice to invest means you’re putting your savings in more than one basket—and that’s a smart savings strategy.

This is not for everyone.

There are two exceptions to taking this advice. Those nearing retirement risk leaving the workforce with a sizeable debt hanging over their heads. The shorter the time frame the more you should focus on paying down your house debt. The only other time to ignore this advice is when you have a massive mortgage. A large mortgage puts you at greater risk of rate shock, when your monthly payments rise dramatically due to an increase in lending rates. The key is to stress-test your debt and examine your cash flow. If you can’t meet your expenses without struggling—either now or in the near future—then your priority should be to tackle debt first, including that massive mortgage.

The decision to pay down your mortgage or invest shouldn’t be based on emotion. Yet we often opt to be debt-free because it feels better. As Ted Rechtshaffen, president of TriDelta Financial, says: “The foundation of every investment decision is that the money you invest should earn more than you owe.” With a longer investing horizon and the power of compounding, sometimes it makes sense to owe a little longer.

12 comments on “Got extra cash? Your mortgage can wait

  1. Romana,
    So you’re saying that the people in Calgary who recently lost their jobs and incurred a 32% loss of their home value are better off than someone who has a paid for home with no mortgage? I bet they are happy that they leveraged their house to invest in the TSX which has lost 12% YTD.

    Your analysis does not adjust for the significant risk of owing a mortgage (of any size) in this unstable economy.

    As your mortgage is paid off, your overall cost of living drops by 30-50% and the risk of job loss and house value depreciation has less of an impact.
    Further, paying off your mortgage is a guaranteed rate of return, much higher than any bank is currently willing to offer.

    Therefore, I’ll keep my paid for house and invest my old mortgage payment…Thanks.


    • Hi Skeptical. You make some great points. I’d like to add that anyone in Calgary that did pay off their mortgage and are looking for a job, may end up having to sell and move to another city where employment is stronger. Unfortunately, selling in this environment would mean less money for your home. If you sank all your money into the home (and focused less on savings) you would have to rely on your sale price (and the profit earned) to rebuild your life elsewhere. While there is no magic bullet when it comes to mortgage vs. savings debate, I think the idea is to appreciate that diversification is essential to weathering tough economic times.


      • What would be your thoughts on having a mortgage of 400K , already paid off 230k (including 25% down) in the past 3 years, and 2 incomes with DB pensions? We like paying off our mortgage and believe both our pensions will be more than enough for retirement. Your thoughts?


        • What is your job security looking like? If this is good, then you are eliminating debt load so you can keep your house in retirement and live off your DB pensions. I assume you are in the govt sector?
          Next retirement planning exercise to do is decide what you want your retirement to look like, and then rough out a budget based on this. Then take an average inflation rate and apply it for the number of years from now to retirement, and see if your combined pensions will cover your budget demands. If the answer is yes, with a buffer, then you are set.
          Don’t forget that when you get old and are faced with moving into an assisted care facility you can sell your house and have that accumulated wealth to look after you in your elderly years along with the pension benefits. This is much better than most people out there.
          You do not mention when you are looking at retiring. Since it looks like you are good savers based on what you have paid down on the mortgage so far in a short period of time, there is also a good likelihood that if you have a way to go before retiring you will also have accumulated other investments outside your pensions.
          You do not mention family situation and other financial demands that you might face. So this would have to be considered as well.


      • I’m no money guru, but having a 32% loss in the value of your home impacts you regardless of whether you own or owe. The amount you owe the bank doesn’t drop by 32% just because your market value drops.

        500,000 market value less 32% (160,000) = 340,000 New Market Value

        If I owned my house: Last year I would have walked away with 500,000 after sale. This year 340,000.
        If I had a 300,000 mortgage: Last year I would have walked away with 200,000 after sale. This year 40,000.

        So explain to me how having a mortgage during an economic downturn was better than having no mortgage?


    • Or use the Smith Maneuver. Your editor was talking about it


  2. Romana… here’s another question that is not really addressed with this column…. What advice would you offer to a couple with approx 35K left owing on their mortgage which will be paid off in roughly May 2016… I’m due to retire in 2020, my Better Half in 2025.
    We’ve been aggressively paying down the mortgage for a couple of years now just to get it out of the way. What’s the ‘better’ approach – ‘slow down’ maybe take half of current mortgage payment and invest, stretch the mortgage out to end of 2016. Or continue with the aggressive payments, finish in May, then take the payment and invest it for the next 5 years or so…. Of note, Job security is there, no issues for either of us in that department.


    • If I was in your shoes I would pay the mortgage off. Depending on your lender you may not be able to change your payments to stretch it out until the end of 2016. Then I would top off a TFSA if possible and then look at investing in other areas.


  3. the backbone of a good investment is that it is line with the investor’s risk tolerance. that’s why the answer to this question will vary depending on each person’s situation. You refer to a “new normal” but your main argument in support of investing vs. paying down the mortgage is a look back at the average annualized return for the TSX over the last 50 years. I don’t think it’s fair to compare today’s markets to returns over the past 50 years. We live in a world of immediacy and information overload. Everyone, individuals as much as corporations and governments, is investing ultra conservatively because we don’t know what effect a war in the middle east, the next terrorist attach or some hacker’s success story will have on the markets and our portfolios. My advice on this topic is always the same: if you’re spending more than you can afford, stop and if you’re invested in something that prevents you from sleeping at night, sell!


  4. Some time ago my wife and I paid down our mortgage, we chose to do that instead of invest, three years later we’re mortgage free and it feels great. It feels safe and it feels like we actually have something. On paper you may earn more investing but if you can pay down your mortgage fairly quickly nothing compares to the feeling of being debt free.

    I could work a minimum wage job and my existing investments would be safe and my family would survive. You cannot put a value on that feeling when you go to bed every night. There are no assumptions or expected returns, just a home that is yours.


  5. This is the worst advice ever!

    What happens when interest rates rise and now you have to renew your mortgage at 4-5% when you’ve been paying 2-3%? The more that you can pay off sooner means more money for you in the future. Like Romana below mentions, the smart Calgarians/Albertans that paid their homes off are now cruising through Alberta bust period. The only way to financial freedom is to be mortgage-free and the sooner you can become mortgage-free, the sooner you can start saving those mortgage payments!

    I’m stil putting money into my RRSP,TFSA and regular Savings but I’m on pace to pay my mortgage at 15 years versus 25 years. My car loan and OSAP wll be paid off within 24 months and that money will be reallocated to pay down my mortgage even quicker which will probably reduce it to 10 years.


    • Not the worst advice at all.
      If your more comfortable paying off your mortgage, fine, nothing wrong with that.
      What the article is saying is even if your rates do go up to 4-5% when you renew your mortgage the average return in the market is still higher then that and you will see greater return as well as more diversification. She also says that its a “perennial debate” because there really is no right answer.
      This article is all correct. Just the fact that more people feel more comfortable with getting rid of the debt first and taking less risk.
      Not everyone is like that and maybe the ones who take a bit more risk will have a bit rougher ride but if history repeats itself (which it usually does in the long run) they will come out ahead.

      I agree with this article AND I see the point of view of all the comments.


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