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Pay Your Mortgage or Invest It

What to do?One of the greatest dilema around for home owners is to assess whether it’s better to invest or pay the mortgage faster. For the past few years, it has been compounded by the low interest rate environment. Considering that home loans from Newcastle Permanent Building Society, known as mortgages, are a necessity for most home owners, the servicing of the debt becomes a daily ritual and an accepted expense for many years. Many forget that in the end, the mortgage loan and interest would usually end up costing twice the value of the original loan. If you take a moment to think about your original loan and you do the math, your eyes must be showing some interesting expression :)

Net Worth Assessment Thought

When it comes to net worth, is it better to reduce debt to grow it or to accumulate assets with liabilities? I know there are two school of thoughts here but liabilities can be costly and when it comes to paying down your mortgage or investing, a lot has to do with your school of thoughts.

Mortgage or Invest Scenarios

Let me look at the flip side of the coin for many scenarios below and please take a moment to share your thoughts.

Why Pay Faster When Mortgage Rates Are Low

I heard this comment many times: “The interest rate is low so I don’t need to pay more on my mortgage.” That thought is very shortsighted considering most will have many years remaining on their mortgage. It’s only a matter of time before interest rate go up and then you are back paying through the nose on your mortgage :( When it comes to mortgage interest, it’s important to understand how it’s calculated and interest is paid up front. The lower your mortgage is the less you will pay in future interest when you renew. The best setup for mortgage payment is to pay bi-weekly, it saves time on your mortgage.

I Can Beat My Mortgage Interest Rates

It is very true that in the low mortgage interest rates we currently have that someone can invest with higher returns. The challenge again is that the interest cost on your mortgage is front loaded where as your investment’s compound growth over a long period. Comparing a mortgage rate and an investment yield is not comparing apples to apples. Can you really prove out that your investment is growing faster than the delta in interest payments you would pay over the life of your mortgage? Investment return aren’t guaranteed either and there is nothing to say that while you may be generating some income, the value of your investment may be going down and will fluctuates.

Tax Deductible Scenario

In the US, your interest on  mortgage is tax deductible so the strategy may very well be different. I would love to hear what strategy is standard in the US.

In Canada, many think about making their mortgage tax deductible by implementing the Smith Manoeuvre but it’s not a strategy that reduces debt. It just transfers your debt from non-tax deductible to tax deductible over time.

My Mortgage Payment Strategy

I personally have accelerated paying down my mortgage as it is relatively large. I have done it by increasing my payments based on my annual salary increase :) At some point, I may slow it down depending on the interest rates as it will be easy to calculate my interest cost and compare with my investment.

With that said, I would personally contribute to my TFSA and RESP before making lump sum payments regardless of the interest rates and the same apply to my RRSP since I get a matching contribution from the company.

Readers: Which camp are you in when it comes to paying your mortgage faster or investing?

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15 Responses to "Pay Your Mortgage or Invest It"

  1. Liquid says:

    I fall in the camp of invest first, pay down mortgage later. It’s true that many forget the interest would usually end up costing twice the value of the original loan. But it’s also true that most mortgages are amortized for 25 years or longer. If someone can get an average return of 5% per year on their investments then they’ll make more than 200% return over the same 25 years. But like you said it’s comparing apples and oranges so it’s hard to determine which one works better in the end. The important thing is to know how interest costs are calculated and to know the risks of increased carry costs when inflation picks up :D

    • The Passive Income Earner says:

      @Liquid
      Thanks for your comment. Would you implement the Smith Manoeuvre?

      • Liquid says:

        Yap I would consider implementing the Smith Manoeuvre in the future. Or I might just set up a simple home equity line of credit once I have enough equity in my home, transfer the money into my investment accounts and make the loan tax deductible that way :) But they keep changing the rules, I think it’s 65% loan to value now, before it was 80%.

        • The Passive Income Earner says:

          I was thinking about doing that once I reach a certain level with my mortgage. I think in 3 years, I will be ready to execute on that. My mortgage is currently at 33% my home value so I have plenty of room but I have not had my home value appraised by the bank to raise equity access. No need as I can already access over $200K.

  2. I’m all about balance so we’ve been investing and paying down the mortgage. One thing we do know is that a mortgage is a sure thing and investing is not. We will have our mortgage paid in full with-in the next month in our 30’s. Now we can invest until our hearts content! Cheers

    • The Passive Income Earner says:

      @Canadian Budget Binder
      Well done! I am so jealous :) I’ll be done in my 40s – just under 8 years to go. I have been investing all along to maximize tax savings and leverage the benefits of different accounts and then I started accelerating my payments.

      I find it easier to accelerate my payments slowly as opposed to add large lump sum but I probably will add lump sum when I can see the light at the end of the tunnel :)

  3. krantcents says:

    I always felt that I could make more money investing excess cash vs. paying down my mortgage. When you consider the low interest rates and the IRS subsidizes your interest rate, I thought it was a no brainer. I feel different as I near retirement (again)! I have a 5% mortgage that will be paid off in a little over 4 years. The balance is relatively small and I cannot refinance. I am paying additional principal which lowers my interest rate to close to the current rate. BTW, I max out all retirement accounts.

    • The Passive Income Earner says:

      @krantcents
      Well done on maximizing your retirement account! I should have included a comment about the US tax treatment :) What’s the strategy generally speaking since the interest is tax deductible.

  4. First off, I think regardless of which route you take you will be putting yourself miles ahead of the average person who neither invests nor pays down debt quickly. So I don’t think either choice is necessarily a bad choice.

    Personally I have chosen to invest for a few reasons:
    1. Mortgage rate is so low and is fixed. If/when interest rates increase in the future, my mortgage interest rate will stay the same at 3.5%.
    2. Inflation. I have a fixed mortgage payment. The dollars I pay towards that mortgage 15 to 20 years from now will be worth considerably less then the extra dollars I will pay towards the mortgage today. I would rather pay my fixed mortgage payment in dollars worth less in future years than accelerating the payment with dollars worth more right now.
    3. Liquidity. I can pay down my mortage and the money is locked up in the equity of the house. If an emergency arises and I need cash I will be forced to tap the equity of my house (at the discretion of the bank) and take out more debt anyways. Or I can invest in stocks and bonds and if an emergency arises I can sell off some of my investments (though I’d rather not) in order to raise cash.
    4. Rates are so low. I currently believe I can earn an investment return higher than the 3.5% rate I pay on my mortgage. This may not be the case every year as some will be better than others but I believe over the life of the mortgage this will be the case. Also if rates do rise at some point I will be able to invest cash in safe Treasury bonds paying interest amounts higher than I’m having to pay on my mortgage. This would be a safe and easy interest rate arbitrage situation.

    Those are the reasons I invest rather than pay extra towards mortgage. But I think as long as you develop a plan either way and stick to it you will end up well ahead of the average person.

    • The Passive Income Earner says:

      @Dividend Growth Stock
      I love the Inflation and Liquidity points you just added. Thanks so much for your comment! It does make me look at it differently even though I have always done both to some extent :) I have had 2.40% (prime minus .6)interest for the past 3 years and will continue to benefit for another 2 years.

      I guess your point 1 and 4 really depends on the type of mortgage one has. I usually have shorter terms (in Canada) and as such, there is always a chance rates will go up.

      I increased payments slowly but I never made a huge lump sum as I was never convinced that shaving a year was more beneficial than earning dividends from my investments and I do have very low interest rate.

  5. Eric says:

    Hi,

    I’m interested in how the logic changes if the mortgage is part of a rental property? I’m renting my apartment out and the rent covers the mortgage payments, strata fees and property tax and I’ve considered paying more to pay off that mortgage but that just seems to set me up to pay more on income taxes when I’m able to write off the interest component along with operational expenses.

    thanks,

  6. Matthew says:

    Great post! This is something I have begun to think about. I’m waiting for my condo to be built and in the meantime I’m trying to save. I think in the end I will invest quite a bit within the first 5-10 years and then focus on paying down the mortgage. I’m still in my twenties so I should take advantage of compounding as soon as I can.

  7. There is no right answer for all people. Tolerance for risk and the freedom and satisfaction and security of having an unencumbered ownership of one’s home are competing considerations. In the US, taking the tax deduction helps and allows other tax deductible items to have a tax benefit. Each person needs to run the numbers and assess their risk tolerance and their personal sense of well being.

  8. Eyeteaguy says:

    I have increase my bi-weekly payments and put a lump sum down every year. My reasons are different from most people though. I need to own my house because my job situation may become volatile. If I own my house and I lose my job my monthly expenses become low and I can withstand the storm.
    I contribute to my TFSA, RESP and RRSP each year as well, maxing them all out.

    Once you own your house you are pretty much free and secure. I will need very little income to “get by”.

    My father-in-law was very glad he paid of his mortgage early. When his wife died suddenly when she was still young (44) he would have been unable to keep up and raise the kids financially with the burden of a huge monthly payment.

    Security can trump growth in some cases.

  9. RICARDO says:

    I would max out the TFSA and use the dividends (tax free) to help pay down the mortgage. But you should, if possible, re-imburse the withdrawn dividends in the following year thus generating more dividends EX if you withdraw $500 from the TFSA and apply to the mortgage you should contribute $6K in the following January. If you have a taxable investment account your dividends will be taxed and therefore reduce the differential in paying down the mortgage. You get the full value using the tax free dividends from a TFSA.
    Any extra monies can always be utilized to further dimish the mortgage. Got morey than the bank will allow you to pay off the mortage? Then by all means try to get a credit margin on th ehouse and invest in div paying stocks. The credit margin is tax deductible fo rth einterest. Hopefully you will have winners and not losers in your stock choices.

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