Mortgages as an Investment
What if I told you there was an ultrasafe investment that paid 6 or 7 per cent annually, guaranteed? Would you be interested?
No, it's not a Ponzi scheme. It's not a stock, either. Neither is guaranteed, in case you needed any reminders after the past year.
And it's definitely not a guaranteed investment certificate. These days, you'd be lucky to earn half of that on a five-year GIC.
So what is this fabulous investment opportunity I'm talking about? It's paying off your mortgage.
I believe – and I know some of you will scoff at the notion, but hear me out – that paying off your mortgage is the best investment you could make. Period.
Why? Because, even with today's ultralow mortgage rates, it's almost impossible to find an investment that is guaranteed to yield a higher after-tax return than you'd get by paying your mortgage down – the key words here being guaranteed and after-tax .
Let's look at an example.
Suppose you have a fixed-rate mortgage at 4 per cent, which is about the lowest rate you can get right now on a popular five-year term. So, for every $100 in principal, you'd be paying $4 in interest annually.
Now, let's say you make a lump-sum payment of $100. You'd be saving yourself $4 in interest, for an effective after-tax return of 4 per cent.
That's pretty good, right? But it's even better when you consider what you'd have to make on a taxable investment to generate the same return.
If you're in a 40-per-cent tax bracket, for example, you'd have to earn 6.7 per cent on a GIC to end up with 4 per cent after Ottawa takes its pound of flesh.
If you can find a GIC that pays anything close to 6.7 per cent, let me know.
Remember, we're talking here about guaranteed returns. Sure, you might do better in the stock market. You could also do a lot worse. The beauty of paying off your mortgage is that the return is risk-free.
(True, inside an RRSP interest income isn't taxable, but you'd still have to find a guaranteed 4-per-cent return to match the benefit of paying down your mortgage. But the highest five-year GIC rate now is about 3.3 per cent. You'll always encounter such a spread, which is how banks make money.)
That raises the question: If the math is so favourable, why don't more people focus on paying off their mortgages early? David Trahair, an accountant and author of Enough Bull , says the wealth management industry has a vested interest in encouraging clients to accumulate financial assets. After all, the more assets a client has, the more the adviser makes in fees and commissions.
“If you pay your mortgage off [aggressively], you have no money to invest with them,” he says.
He adds that, unlike in the United States, mortgage interest in Canada is not tax-deductible, which is another reason it makes sense to focus on becoming mortgage-free as early as possible.
Of course, by fiddling with the assumptions, one can make paying off the mortgage look like a terrible idea. If one assumes, for example, that the stock market will generate returns of 10 per cent annually, then investing in stocks is the way to go. But that's all it is – an assumption – and if you're prepared to take the risk, then go for it.
Let me be clear: I am not against owning stocks. I own some myself. A few are even higher than they were a year ago.
On the other hand, in these uncertain times – with the recovery still fragile and stocks having already had a big run – a guaranteed return counts for a lot.
That's one reason Derek Moran, president of Smarter Financial Planning Ltd. in Kelowna, B.C., puts “every extra cent we get” into his mortgage, even though he has a very low variable-rate mortgage.
“I'm a big fan of paying it down because I don't think interest rates are going to be this cheap for that long, I really don't,” he says. “The after-tax return on paying off debt is quite good … and you're taking risk off the table.”
Once your mortgage is paid off, you can always borrow against your home and invest the money, he says. In that case, as long as you're earning investment income, the interest would then be tax-deductible. As for emergencies, a credit line should suffice.
Focusing on paying off the mortgage has other benefits, both financial and emotional. It's a forced savings plan, and it gives you a goal to work toward.
When you finally pay the mortgage off, you'll have far more financial flexibility – to invest, save for your kids' education, cut back to part-time work, live on one salary instead of two, take a vacation, or countless other things.
So the next time you're sweating about where to invest for the highest – and safest – return, look no further than that roof over your head.
(c) 2009, The Financial Post, Used by Permission