Extra cash? How to choose between paying down your mortgage or investing

By Ashley Land

August 23, 2019

I’m currently working through an investment/debt repayment scenario that may be of interest for our readers, so I thought I’d share it with you.

Here’s what’s happening.

I recently received notice from my bank that my mortgage is up for renewal, which has prompted me to begin researching different renewal options. I am also in a situation where I have saved money throughout the year and have extra funds available that I can use to either pay down my mortgage or invest.

The first thing I did was reflect on the pros of paying down debt versus the pros of investing.

Pros of paying down debt

Peace of mind
Save on the interest costs of the mortgage
Reducing my mortgage will lower my expenses and cost of living
I will move closer to my ultimate goal of “Financial Freedom” by increasing the percentage of my assets that I own

Pros of investing

Historically, the long-term investment performance of equities outperforms low mortgage interest costs
Diversification of assets – I would hold equities as well as real estate
Liquidity – I’d be able to sell the equities I purchase in case of an emergency, which isn’t an option with my home
Contributions made to a RRSP offer tax deductions

There are advantages on both sides, so let’s look at some numbers to explore my options.

Let’s assume I am comparing paying $25k down on my $300k mortgage (which has an interest rate of 2.85%) vs. investing $25k in my RRSP at a 5% rate of return.*

Option 1: Pay down mortgage

If I put $25,000 towards my mortgage, my amortization period reduces to 22 years from 25 years. Once the mortgage is paid off, and I continued to invest the equivalent monthly mortgage payment into my RRSP, it will be worth $70,767 by the end of the 25 years.

Option 2: Invest $25,000 into my RRSP

If I contribute $25,000 into my RRSP, my savings over the 25 years will be $114,087.

So what was my verdict? I did both.

Here’s why.

I started by investing extra cash I was considering applying to the mortgage in my RRSP. This allows the money to grow tax deferred, meaning there are no taxes owed on capital gains or dividends earned while in the plan.

By investing in high-quality dividend-paying companies featured in the Richard Dri Canadian Dividend Model, my money is in companies such as Power Corp of Canada, which is paying me a current dividend yield in excess 6% and has already increased its dividends in 2019.

But that’s not all.

When I make my maximum allowable RRSP contributions, I am able to reduce my taxable income. I can then use my tax refund to make a lump sum payment on my mortgage.

By following this approach on a long-term basis, I am able to steadily pay off my mortgage while also continually investing to achieve my other goals.

It’s the best of both worlds.

Oh, and one other thing: To pay off my mortgage faster, I have it set up for bi-weekly payments. Because there are 52 weeks in a year, this approach leads to the equivalent of an entire extra month’s payment compared to paying monthly. Because I am used to the money coming out every two weeks, I have budgeted for it while paying down the principal on my mortgage more quickly and reducing the term of my mortgage.

Curious about your options? Give us a call and we can run the different scenarios for you. Call or email me at ashley.land@scotiawealth.com.

Note: The above information is generalized. Each person’s specific context needs to be considered before the best course of action can be determined.

References:

RRSP vs. Mortgage Calculator

Mortgage Calculator

*Assumptions:

Let’s make the following assumptions:

Cash: $25,000
Mortgage: $300,000
Monthly Payments: $1,396
Interest rate 2.85%
Investment rate of return: 5%
Marginal tax rate: 30%

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