The age old question: should I pay off my mortgage or invest the money?
So here's the situation.
You have a 30 year mortgage on your home and you're 8 years in. You bought the house for $350 000 and things have been going just fine since then. You've been making your payments on time, and you renewed with your bank 3 years ago.
Then something incredible happens... you win the lottery, a rich uncle you've never met passes away, money falls from the sky.
How it happens isn't really important, the important fact is that suddenly you've got enough money (after you pay the taxes) in your bank account to pay off the rest of your mortgage in full.
The question is: should you invest the money or pay off your mortgage?
This is more complicated than it first seems and it will depend on a variety of factors. The first step is to analyze your current financial situation, including your mortgage and then ask yourself the following questions:
- What market are you thinking about investing in?
- What is your risk tolerance for investing?
- What stage of the economic cycle is the market in right now? What you really want to know is what your expected Rate of Return will be.
- Is there anywhere else you should be putting your money? Places like an emergency savings fund, college savings for your children, or other forms of debt you should pay off first.
- How much will it cost to break your mortgage?
Comparing your options
Initially, the decision might seem to be pretty easy. Just compare the interest rates. Pay off your mortgage and maybe you'll save 3.5% in interest. Invest the same amount of money in a market index fund and you'll earn an expected 7-8% return. Seems like an obvious choice.
But it isn't necessarily that simple.
Past performance is no guarantee of future returns. No matter what you invest in there is always a chance that the market will go down. This is where your risk tolerance comes into play.
How much risk are you willing to expose yourself to? The higher the risk, the higher the reward, but each person's tolerance is deeply subjective. You will have to really explore the question and discover the answer for yourself.
Another factor will be the costs associated with breaking your mortgage. You will have to factor in the expense associated with that into your calculations. Most lenders will charge three months interest to break a mortgage, in this case you would be looking at over two thousand dollars to pay off your mortgage early. How would that affect your decision?
And in some cases the choice will already be made for you. Some lenders don't give you the option to break your mortgage at all. In that case, you're going to have to wait until the mortgage matures before you can get out of it.
One of the other considerations you should look at is the other areas you could be putting that money.
The average household in Canada is carrying over $22 000 in consumer debt. That kind of debt often has interest rates of 20% and higher.
Before looking to pay off your mortgage, you should always address your unsecured, high interest rate debt first.
Just as it doesn't make sense to have your money sitting in a savings account earning 1% (if you're lucky) when you're paying 24% on your credit card, the same applies to investing.
Deal with your credit cards and other high interest debts first.
The easiest way for someone to earn a 20% or higher return on their money is by paying off their credit card as quickly as they can so they stop paying for the privilege of owing money.
Should I pay off my mortgage? Do your homework to find out
In the end, you are going to have to crunch the numbers to learn what your best move is. But here's a pretty simple guideline to help you make that choice.
Pay off your high interest rate debt first. Then, and only then, should look at investing your money.
Find a fiduciary and speak to them about your options for investing your new found money. If you find something that fits your investor profile and risk tolerance, invest away. Your fiduciary will guide you through the process and help you make good decisions in regards to diversifying your portfolio.
As long as the expected Rate of Return is higher than the interest rate you are paying on your mortgage, a good rule of thumb is: it is better to invest than to pay off your mortgage, as long as you are comfortable taking on the associated risk.
This really comes down to a question of opportunity cost.
Which path will create the most wealth for you over the long term? Saving the interest rate on your mortgage or make the interest rate on an investment?
The choice is up to you.
The good news is the Ardent Mortgages team would love to help you find the solution you're looking for. Click the button below to take our 90 second application and get your free, no obligation consultation.