Q: My husband and I are struggling with the classic “do we pay down the mortgage or do we make minimum payments and put all of our extra money into investments” question. Our situation is a bit unique in that we are in our early 40s, have no consumer debt, one adult child, we owe about $200,000 on our home and have about $250,000 in investments. We earn just over $200,000 per year combined and would like to buy a second home in a warmer climate, but we aren’t sure what would be the best financial strategy to make it happen.—Chantal
A: You’re not unlike many Canadians, Chantal. You have limited dollars chasing multiple priorities. Making the right choice boils down to prioritizing and projecting. If you prioritize your goals and project the likely outcomes, you can decide if the financial and lifestyle implications are in check if you make one choice over the other.
Here’s the thing: Mortgage debt repayment is investing. Your return comes from interest savings that accrue by paying down the principle portion of your debt. Interest rates may be low right now, but they are likely to rise in the medium term. So paying down principle today will save you a bit in interest today and a lot tomorrow, especially if your debt is likely to still be outstanding five or more years from now (like many mortgages).
Sometimes, people choose to invest instead of paying down debt. If you think you can earn a higher rate of return on your investments than the interest rate you’re going to pay on your debt, in theory, you’re better off. In practice, it depends.
Over the past 30 years, the 5-year posted fixed mortgage rate has averaged about 7%, though we all know the discounted rate is lower. Canadian stocks and bonds have both returned about 9% annually on average, while U.S. stocks have returned about 10%.
And while it doesn’t seem like much of a feat to earn better than 3% returns on your investments relative to current mortgage rates in the next five years, fixed income returns are low and stocks have been in a 5-year bull market, so high returns in the next five years may arguably be more challenging than in the past five years.
If you and your husband are going to invest instead of paying down your mortgage, I’d suggest you do what you can to make your mortgage interest tax-deductible, if it isn’t already. If it’s not, you can consider using your non-registered investments to pay down mortgage debt. If you then borrow to invest, the interest is generally tax-deductible. I’m always leery to borrow to invest, but you’re really already doing it if you have debt and investments at the same time.
Given that your investments are earmarked to buy a second home in a warmer climate, I’d make the argument that you should consider investing in that second home now. If you invest in stocks and bonds with the intention of then pulling out that money to buy the home, why not consider investing in the home in the first place?
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If that warmer climate is in the U.S., prices have started to rebound, but are still quite low based on a number of metrics. Beyond that, there are a lot of baby boomers who are dreaming of a vacation property down south these days. Turning those dreams into reality likely means rising prices.
Even if you’re not in a position to use a potential vacation property as much now in your 40s as you might in your retirement, you can consider renting the property out in the interim. Property management companies can facilitate this for you, typically for a fee of 10-20% of rents collected, depending on their level of service.
It’s not to say that U.S. real estate is a better investment than stocks or bonds. Or that either of these is a better investment than paying down your mortgage. But there are always different ways to pursue your goals. Weighing the potential financial and non-financial implications of your decisions will help you choose the right path for you.
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.