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Paying down debt, should I change my tune?

Friends of My Own Advisor know I don’t like debt.  Since moving to our current home and taking on a fat mortgage, I struggle now and then with our debt load.  My wife and I are fortunate to have good jobs but you never know when that might change.  On that note, I can only control a few things when it comes to my job, namely my performance and behaviours on the job: do what is asked of me and more; complete my work effectively and efficiently; be professional; continue to mature my subject matter expertise and acquire new skills when and where I can.  With a significant reorganization underway at work the future looks both promising and cloudy.  With that weather forecast, you think I’d want to kill off debt much sooner than later.  Lately, I’ve been considering the opposite:

While paying down debt will continue (I can’t stop my mortgage payment), I’m wondering if I should stop making lump sum payments on my mortgage for a short period of time (1-year) and invest that money instead?

Our mortgage is easily our largest monthly expense.  Our bi-weekly mortgage payment plus our lump sum payments constitutes over 30% of our net income.  If we are lucky to keep the borrowing rate fixed in the future, and we march on with our current lump sum payments, the mortgage will be killed in eight years.

On the flip side, while extra contributions on our mortgage seem like a great thing to do in this low-interest rate environment, these payments are competing with my investment objectives.  I could probably earn a better yield from a basket of dividend paying stocks or a better return from the appreciation gained by broad-market Exchange Traded Funds (ETFs) over the “guaranteed return” my mortgage payments provide.  To date, my approach has been to tackle both; take down the mortgage using prepayment privileges and buy investments when I can afford to.

Focusing on investing over the next 12 months would likely see:

  • The Tax Free Savings Account (TFSA) maxed out sooner, and
  • Registered Retirement Savings Plan (RRSP) contributions increased.

The downside:

  • The mortgage will take longer to pay off, and
  • We’ll need to borrow more money when our mortgage term comes up for renewal.

Decisions, decisions…

What would you do?  Focus on debt reduction?  Focus on investing instead of lump sum mortgage payments – making money work longer for a larger reward?  Do a little bit of both?

Filed in: Debt

20 Responses to "Paying down debt, should I change my tune?"

  1. Robb says:

    Tough call, Mark. On the one hand, I know you want to kill off that mortgage sooner than later. Extra contributions are the only surefire way to do that. On the other hand, it’s very tempting to let the low interest mortgage debt ride and put more money in the market.

    We have a similar dilemma and have decided that, of the three areas we could contribute to, we’d forego TFSA contributions in favour of maxing out my RRSP and making extra mortgage payments.

    We’ll try to catch-up quickly on our unused TFSA contribution room once the mortgage is paid off.

    • Hi Robb,

      Yes, tough call indeed….I go back and forth on this. To date, I’ve decided on a defined lump sum mortgage prepayment every paycheck and then, with any money leftover that is invested. We’ve got work to max out the TFSA this year, then I’ll put some money into the RRSP as well.

      Given all your priorities, probably a smart move to not bother with TFSA until mortgage is paid off.

      Thanks for your comment.

  2. MG says:

    Hi MOA,
    Interesting dilemma but I hope you are not caught up in thinking that you are “missing out” on all the great gains to be made in the stock market.

    I am confused by your downside of needing to borrow more money when your mortgage comes up for renewal. Why is that?

    Regards,
    MG

    • Hey MG,

      No, not “missing out” on some stocks, since they are priced rather high. I only see a handful of deals in the U.S. but a few here in Canada….

      What I mean is, if I don’t make lump sum mortgage payments now, my borrowing costs for my mortgage when it comes up for renewal will be higher. Lump sum payments are reducing my principle. If that doesn’t come down more, I will pay more interest.

  3. A towering pinnacle of financial common sense from Ottawa once said:
    “if you have debt, and are saving money, you aren’t really getting “ahead” at all.”

    Actually, he said that just last week:
    http://www.canajunfinances.com/2013/07/30/im-not-paying-my-debt-but-i-am-saving-money/

    I believe he also noted somewhere that your investments aren’t producing a guaranteed rate of return. But if you pay down debt, then that is pretty much guaranteed – since you know you have to pay the rate of return on the debt.

    Personally I’d carve the mortgage out from consumer debt. Consumer debt, get rid of at all costs. The mortgage? Meh. For me a mortgage is more ‘you have to live somewhere’. If it’s not a crazy debt load to carry, I wouldn’t worry about it (other than normal mortgage reduction techniques). If you’re going to treat the mortgage in the same fashion as consumer debt, then you have to delve into the whole renting vs. buying. And since you’re buying not renting, then the base assumption is, hey, you gots a mortgage.

    • Towering pinnacle…nice :)

      Always a good point, debt payments are guaranteed but I struggle with paying down a 3% mortgage when I know TD stock is yielding 3.7%. There are many more stocks yielding better than TD.

      For now, because the mortgage is over $200k, it needs to be paid down more aggressively. I guess I’ll continue to do that. Any money leftover is going for investments though.

      Thanks for your perspective Glenn.

  4. …but if you want to run the numbers, see my mortgage vs. rrsp calculator:
    http://www.lifeinsurancecanada.com/mortgage-vs-rrsp

    After playing with the calculator, my general rule of thumb is, pick one and go with it. Too many variables, and the outcomes are reasonably close, so no clear winner.

  5. Liquid says:

    It can be difficult finding the right balance between paying off the mortgage and investing. I would say your strategy should depend on how long your time horizon is. If one focuses on paying off debt in one year and then aggressively invests the next year it’s hard to recover if Murphy’s law decides to do some serious short term damage.

    Statistically in the past there is a 20% chance of losing money in the stock market if the index was held for any 5 consecutive years. Personally I plan to invest in stocks for 20+ years so I’m not too concerned about that risk. All of my disposable income has gone into investing since I started working and I’ve never made a lump sum mortgage payment yet. Most people would agree with you that low interest rates right now would be the best time to pay off the mortgage :D But I’d rather use this opportunity to buy financial stocks like banks and insurance companies. And then whenever rates go higher again, those company’s stocks should inevitably increase as well.

    If mortgage rates go up just 1% that means someone with a $250,000 mortgage will pay an extra $2,500 every year to the lender. Multiply that by however many people have mortgages and there’s a gold mine waiting to be realized :) It’s just a matter of time. Then I would take the profits from my stocks, after they’ve appreciated, to pay down the mortgage. I think higher interest rates would be a good time to pay down debt, but low interest rates is a good time to invest in assets that will benefit from higher rates in the future. Obviously I could be totally wrong and we may see a correction in the stock market while interest rates rise, but I like to be optimistic about things :D

    • “Statistically in the past there is a 20% chance of losing money in the stock market if the index was held for any 5 consecutive years.”

      Really, interesting…

      I’m with you when it comes to investing, I plan on being invested for decades to come.

      As for interest rates, you’re right. Lifecos, banks and other financials stand to make a bunch of money. I guess I’ll keep those stocks.

      Thanks for your detailed comment!

  6. We balanced both Mark because we wanted to be mortgage free before 40 and accomplished it much sooner which for us was a win. Although it’s taken us 4 years to pay off our current mortgage we’ve both been homeowners in the past so we’ve made money. When we bought this house we were able to put money into investments while paying this down faster. We don’t regret that although I’m still waiting for the last of my money to finalize it all. It’s really what makes you happy. We didn’t want to risk interest rates going up nor did we think we could make more than 4% investing because we don’t do it on our own like you might. You might see something different out there that is a sure thing because you are in tune with investing and know what you are doing, where i don’t. The mortgage was a sure thing to us.. it is what it is. I’m sure you’ll sort it out in the end. Good luck mate.

    • Mortgage free by 40, uh, I wish!

      I wouldn’t regret that for a second, and kudos to you for doing all that hard work!

      The mortgage is a sure thing, and maybe for the short-term I will do both. This way, I keep the best of both worlds.

      Thanks for the encouragement and following along Mr. CBB. Great to have dedicated readers like you.

  7. My opinion is that if you have room on your RRSP or TFSA, and your choice is to make a lump sum mortgage payment or a registered contribution, that you should make the registered contribution. The benefits of RRSPs and TFSAs are magnified by time.

    You should run some numbers. Check the value outstanding on your mortgage when it comes up for renewal, and see how much of an interest rate increase you can absorb. Also, remember that variable rate mortgages are becoming more attractive. Despite the 0.5-0.8% increase in fixed rates, variable haven’t moved an inch – still prime (3%).

  8. Personally I’d just hammer the mortgage and get it over with. I know it’s a simplistic way of looking at things but a mortgage is the one biggest financial commitment most of us make in life and just imagine the feeling you’d have if you were free of it! I think that feeling would far outweigh the extra investment potential. Plus what if – I know it seems unlikely – rates did rise significantly in the short-medium term. You’d again be mighty glad you paid off that mortgage early. I’m interested to hear what you do :-)

  9. Hi Mark,

    My mortgage is the biggest expense I have as well. So whenever I have saved a significant sum, I have the same choice to make: invest or repay part of the mortgage. Up to now I have always decided to invest the sum and not to repay. I’m thinking that when I repay part of the mortgage as a lump sum, I will lose (part of) the tax deduction and have to pay several months of interest as a penalty. For the moment I feel more comfortable to build a nest egg on top of my home equity rather than increase the home equity itself. But that is just my personal opinion, probably also because the remaining mortgage balance is well below the current value of my property.

  10. Bet Crooks says:

    I don’t think there’s a “right” answer. The truth is whichever way you choose you are improving your finances considerably.

    Don’t lose sight of that. You could be trying to decide whether to spend the extra money on a luxury vehicle or a not-really-important-to-you vacation. Those would be the kind of choices that would be worth getting upset with years from now.

    Personally, given you said there’s some job uncertainty, I’d top out both your TFSAs, then make lump sum payments on the mortgage. Keep the TFSAs fairly liquid in case they need to be used to pay expenses if the worst happens.

  11. I love the new look! The design is really nice and easy to navigate. Congrats!

    I would do a little bit of both. Maybe 40% debt reduction, 60% investing. A balanced approach is usually more successful

    • Thanks for the kind words about the site Daisy. I know I’m biased, but I love the look!

      I think I will continue to do a bit of both, kill debt and invest. Balanced might be the right thing to do and the best of both worlds.

  12. IMHO says:

    Both but with this twist.
    Rent out your basement.
    Take the extra rental income and put it towards your investments.
    Take the “extra” money after monthly expenses and put it toward your mortgage.

    The improvements you have to make to get a basement apartment are an expense when you do your taxes. Which is applied against the income from the apartment. The interest from the mortgage, house insurance, furnace filter, lawns maintenance and half of any house expenses are also applied against the income from the apartment when you do your taxes.

    Most times you have more expenses (especially if you have a large mortgage) then income from the renters. Hopefully, depending on your income that generates a tax refund. Which can be put towards the Home Buyers Repayment you have to or your investments.

  1. […] August 2013 – Friends of My Own Advisor know I don’t like debt, which makes having my fat mortgage more than annoying.  Even so, I wondered if investing more would be better than paying down debt and asked readers if I should cha… […]

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