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Pay off your mortgage or invest?

If you were to focus on paying off your mortgage debt or invest today, which would you choose? Whichever side people are on, it always seems they’re really adamant about one side or the other. Personally, for me, financial security is always top of mind, so it’s a pretty easy decision. But it’s not always so cut-and-dry.

Any articles I’ve read about investing and many financial advisors I’ve dealt with at the bank, always like to talk in terms of percentages and rarely about the actual money made/saved. Why? Well, for one, saying you’d be earning eight percent per year sounds a heckuva lot better than earning only $200 on a $2500 investment to the average Joe/Jane investor. Yes, if you have a sizeable amount of investments, you’re 8% will go a lot further, but you’re also probably a lot less likely to read this blog.

By the numbers

When I first started investing, I started with approximately $5,000. If we look at an average two-parent Canadian family with children, they brought in an average income of $88,900 after-tax, by 2010 standards. The average personal savings rate in Canada at that same time was 4.8%. If we take those numbers and assume everyone put all their personal savings into investments (just for fun), they would be contributing an average of $4,267 per family per year. Now the average is probably a lot lower than that, but let’s use $5,000, for the sake of simplicity.

The average price of a home in Canada is about $350,000. Yes, some areas are more, some are less. Although there are many other variables to consider, using those figures, let’s take that $5000/yr investment (invested at the start of the year) and $350,000 mortgage at a 2.99% interest rate as a starting point and see which could save you more over the long-term.

Investments vs. mortgages

Numbers don’t lie but may be deceiving

Using the above tables as an example you can clearly see that even if you have any sizeable mortgage, over time, investing is surely the way to go. Or is it?

There’s always ups and downs. Although the charts assume you’ll be earning the same exact percentage on your investments every single year, that’s never the case. Yes, while historically, the TSX has posted some pretty decent returns in the past, it’s also declined by almost 3% in the last five. The housing market is no different. The charts above assume a fixed 2.99% mortgage rate for the life of your mortgage, which is highly unlikely. Rates are at all-time lows, so when you factor in rate increases and switch from monthly payments to bi-weekly, paying down your mortgage starts to look a little more attractive (although, maybe not nearly as attractive as the investments, until I get to my next point).

A home can be an investment too. It’s a point often forgotten. Looking at comparable homes in my neighbourhood, my property value alone has increased over 50% in the past 6 years. Not a bad investment!  So when you look at it that way, the numbers start to seem a lot closer.  Sure, maintenance on your home can start to erode at those percentages too, but when you factor that in over the long-term, it’s not a whole lot and the housing market in Canada has also been a lot less volatile than the stock market has. Also, if you run a home-based business, you can deduct a portion of your mortgage interest and property tax from your income taxes. And you can use that money either to continue to pay down your mortgage or, you got it – invest it.

Time is money. On a 10-year investment, for example, to get the earnings above, you would have to invest $50,000 ($5,000 per year for 10 years). By comparison, on a $250,0000, ten-year mortgage, because every prepayment works to pay down your principal faster, prepaying $5,000/yr. will work to pay off your mortgage 21 months sooner. This means you can free up time and money by turning around and investing those almost $10,000 over the next two years after your mortgage is paid off. On top of that, if you’re just paying the minimum to your mortgage and investing, the debt on your mortgage is still increasing. This means whatever gains you get from your investments will be hampered by the extra debt-load that’s added to your mortgage. But then there’s also a lot of definite tax advantages to choosing investments too. Investments are taxed at a much lower rate than income and when held inside an RRSP account, all investments grow tax-deferred.

Decisions, decisions, decisions

So as you can see, there’s a lot of different things to consider, so which do you choose? It’s hardly an either-or, and it shouldn’t be. But in my opinion, paying off the mortgage first ultimately gives me a guaranteed rate of return and a nice cozy home I can live in. And it gives me one more thing that I may/may not get from my investments… peace of mind.

So what do you choose? Do you focus on the one asset you’re living in, knowing you’re going to have to pay it off anyway, or do you sink your money into the stock market?  What do you think? Am I totally bananas? Agree? disagree?

Investment compound interest calculations from moneychimp. Mortgage calculations from the Financial Consumer Agency of Canada.  
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