Paying down your mortgage and investing are both important goals; however, combining long-term investing and paying down your mortgage can offer the highest financial return. Surprised? Most people are.
Let’s first look at how a simple long-term investment can outperform mortgage-interest savings.
Then we’ll examine the benefits of paying off your mortgage and investing.
We’ll start by weighing the pros and cons of the first option – paying off the mortgage.
Pay Off the Mortgage
Interest rates are rising, making homeowners fear that less of their monthly payments will go to equity and more to interest. A 25-year term can feel overwhelming, so understandably, there is a strong urge to pay that debt down fast, especially if there is extra money in your monthly budget. Or you receive a financial windfall like a raise! Decisions, decisions.
Pros of Paying Off the Mortgage
- You’ll save on interest. How much you’ll save depends on what you owe, the amortization period, and the prevailing interest rates. For example, you receive a windfall of $50,000 and decide to make a one-time payment on your $600,000 loan with a 25-year term. Your interest rate is 4.5%, and your monthly payment is $3321. By the end of the 25-year term, your $50,000 prepayment will save you $63,963 in interest. Not bad.
- You’ll be debt free sooner. You’ll have peace of mind knowing you are much closer to owning your home outright and freeing up those monthly mortgage payments for something else.
- You can leverage your equity. For example, paying down your mortgage means you can use the equity to open a home equity line of credit (HELOC).
- You’ll have less cash on hand. Paying off your mortgage means having less money for day-to-day expenses. Will you have enough money in your budget for the daily costs of running a household and for emergencies?
- Your home might be the only investment you can afford. Will you have enough to invest in your retirement savings plan and registered education plans for your children?
- Beware of prepayment penalties. Your mortgage agreement may include significant penalties for paying down or paying off your mortgage.
- You might lose out on income tax savings. If you work from home, run a business from your mortgaged property, or rent a portion of your home, you may be able to claim mortgage interest and fees on your taxes and reduce your income tax owing. However, paying off your mortgage will impact your ability to claim these credits.
Investing could make you more money than if you were to apply a prepayment amount to your mortgage.
- Investing can earn you more money than you will save on mortgage interest. So, let’s look at your $50,000 windfall again and compare your mortgage interest savings of $63,963.00 against potential investment earnings over the same 25-year period at the same rate of 4.25%.
If you invest $50,000.00 at an annualized rate of 4.25% when compounded monthly, your $50,000 will be worth $94,408.00 after 25 years.
If you add just $100.00 a month for 25 years to your $50,000, your investment will be worth $117,721.
- Investing is an effective way to put your money to work and build wealth.
A diversified investment portfolio could allow your money to outpace inflation and increase in value. Stocks and, or mutual funds could yield a (much) higher rate of return than 4.25%. Also, if you invest in registered accounts like your registered retirement savings plan or tax-free savings account, you can benefit from some tax savings from your invested money.
Investing carries risk. No investment is guaranteed; yes, you can make money, but you could also lose money if returns are poor.
- How much time is left on your mortgage? If you are almost at the end of your mortgage, investing a windfall won’t give you time to grow your investments, and the short term could expose those investments to more risk.
- How much risk can you tolerate? For example, GICs and Canadian Bonds grow more slowly than equities and stocks, but their risk factor is low. Conversely, equities and stocks offer the most significant potential for higher growth, but their risk factor is higher.
- Successful investing requires expertise. Financial advisors can help you navigate the risk factors of investment products and will charge fees for their expertise.
How to Pay off your Mortgage AND Invest
In a perfect world, we wouldn’t have to choose between paying off our mortgage or investing our hard-earned money to build wealth, but there is a way to do both simultaneously and come out ahead.
Make your mortgage tax-deductible using a strategy called The Smith Manoeuvre.
Robinson Smith’s best-selling book, Master Your Mortgage for Financial Freedom, teaches you how to use The Smith Manoeuvre in Canada to make your mortgage tax-deductible and create wealth.
Use The Smith Manoeuvre.
In an article published by the Toronto Star this year, Toronto wealth advisor Ron Haik discussed the benefits of The Smith Manoeuvre for Canadian mortgage holders.
“The Smith Manoeuvre allows you to convert non-deductible mortgage debt into deductible debt. You first pay down the mortgage, then borrow back the amount of principal that’s been repaid so that you can invest it. Your investments should be greater than the cost of borrowing to generate further income, which will be used to further pay down the mortgage debt.
The advantage to The Smith Manoeuvre is that you’re building up a large investment portfolio while paying your mortgage off.
You’ll be able to pay down your non-deductible mortgage quicker, depending on the return in your portfolio versus the cost of borrowing,” he said.
What is The Smith Manoeuvre?
The Smith Manoeuvre is a creative, legal financial strategy designed for Canadian homeowners to convert the non-deductible debt of a house mortgage to the deductible debt of an investment loan. This strategy simultaneously enables the speedy elimination of a non-deductible mortgage while building a free-and-clear non-registered ‘personal pension portfolio’ and enjoying substantial tax refunds annually for many years.
In his book, Robinson Smith describes how the typical Canadian homeowner who implements The Smith Manoeuvre could realize a benefit of approximately $400,000 or more over the life of their 25-year mortgage.
Since the strategy’s development, Canadians have been using The Smith Manoeuvre to keep more of their money to reduce home ownership costs and improve their financial security.