Should you only put 5% down on your mortgage and invest the difference?
The following is a guest post from a reader named Gruff, who wonders why on earth investors would strive to put down more than 5% on their mortgage today – when they can invest the difference instead.
I must say, I read Mark’s post here with great intrigue.
The definitive answer to paying down your mortgage or investing
In particular, this caught my eye:
“The bottom line – if you expect the rate of return on your investments to be consistently higher than your mortgage interest rate over the life of your mortgage, you will have more money by paying the minimum amount on your mortgage, and investing the difference inside your TFSA or RRSP.”
I happen to agree with Mark but this post takes things a step further. I believe if you’re a new homebuyer you should consider only putting 5% down on your mortgage, and investing the difference.
CMHC is a mortgage deterrent but you should know better
When you get a mortgage from your financial lender you may be required to also purchase mortgage insurance through the Canadian Mortgage and Housing Corporation (CMHC).
Backing up a bit, mortgage default insurance, which may be commonly referred to as “CMHC insurance” is mandatory in Canada for house purchase down payments between 5% (the minimum) and 19.99%.
Essentially this insurance protects lenders if you stop making mortgage payments and/or default on your borrowed money.
Although it sounds a bit harsh, you could argue this does allow Canadians (who might not otherwise be able to afford a home) entry into home ownership. Sounds odd I know (you must take insurance so you can own a home you can’t otherwise afford but I don’t make the rules).
Here is the table and rates from CMHC:
- The CMHC Mortgage Loan Insurance premium is calculated as a percentage of the loan; based on your down payment. The higher the percentage of the total house price/value that you borrow, the higher percentage you will pay in insurance premiums.
- Without mortgage insurance you may avoid the insurance premium but you’ll typically pay much higher interest rates and additional administrative fees.
Why just 5%, why not 20% or more?
You know from above you must have a minimum of 5% down payment.
When I talk to friends and teacher colleagues about real estate, mortgages and more, I hear that most people think it is best to have a 20% down payment (or more).
I counter this by saying this is not necessarily true especially if you can comfortably handle a larger mortgage payment.
In fact, in a prolonged, low interest rate environment I think you’re going to get ahead by only making a 5% down payment and investing the difference.
Here is my example for today to consider.
In 1995, my friend Sandy wanted to buy a house costing $130,000. (I know, 1995 prices but read on.)
Her interest rate was 6.5%. She took a mortgage amortization term of 25 years. For simplicity, I’ll use an average of 6.5% for all the mortgage calculations. Mortgage rates were much higher in the 1990s than today.
Sandy has the $26,000 (20%) saved at time of purchase.
Should she put all this into her down payment and eliminate the CMHC fee?
I know my answer but let’s look at some numbers first generated by the CMHC calculator on their website.
|Down payment||5% ($6,500)||20% ($26,000)||$19,500|
|Mortgage payment amount||$860.32 monthly||$693.27 monthly||$167.05|
|CMHC insurance premium||$4,940.00||$0||$4,940|
|CMHC insurance rate||4.00%||0.00%||4.00%|
What does this tell you?
At first glance it appears that 20% down payment is the best idea – it’s going to save you a bundle in interest costs plus $4,940 insurance premium over the life of the mortgage.
In 1995, what happened if my friend Sandy put 5% down and instead invested her $19,500 difference in TD Bank stock? (You may also know that TD Bank is her mortgage holder as well.)
I played with some numbers for this post.
According to the investment calculator on the TD website, on June 26, 1995 Toronto Dominion (TD) stock was worth $5.32 so that $19,500 would have purchased about 3,660 shares (give or take a few shares).
Using June 30, 2020 as the end date, Sandy’s original investment would grow to over 8,400 shares worth $60.59 each.
By reinvesting the TD Bank dividends and thanks to the power of compounding via dividend reinvestment plans that Mark writes about, the calculator showed me my friend Sandy would have over $500,000 worth of TD stock to live from or enjoy, in the middle of a global pandemic and economic disaster no less!
(In fact, in early 2020, TD stock was worth over $75 per share before the pandemic. Her shares would have been worth over $620,000 at that time.)
It’s not all about TD stock but investing time is always on your side
Mark recently wrote about a nice post worth mentioning here again:
He highlighted again his passion for investing, striving towards semi-retirement, and reminded his readers that time in the market is your friend.
What could have happened in my example with TD stock could have happened to some degree with Royal Bank stock, Fortis stock, Enbridge stock and many other dividend stalwarts in Canada.
My point is – time in the market (and staying invested throughout) can be your friend just like Sandy is to me!
Other considerations and food for thought when investing the difference!
I’ll start by saying past performance is no guarantee of any similar future performance. Like stock prices, housing prices go up and down regularly. Like housing, any individual stock investing decision should be considered a long-term strategy to avoid market timing.
Also consider, like the times we are living through now, although unprecedented with COVID-19, lots of bad and unforeseen things did happen between 1995 and 2020. We had a tech bubble burst. We had a global financial crisis a decade ago. We witnessed the U.S. housing market collapse (and then rebound). Oil prices shot up, then dove. We now have a global pandemic to endure. Throughout history, Canadian banks have done rather well and TD in particular has paid dividends to shareholders without fail.
Mortgage interest rates are also unpredictable. They could rise or fall. Over this 25-year time frame (1995 to 2020) we’ve all seen the interest rates trend downward and they are likely to stay down for the coming decades – but who knows!
In 1995, all you had was an RRSP in your asset accumulation years to shelter and defer taxes. Now, should you wish to invest in TD stock or any other Canadian dividend paying company, I think you should do so inside a Tax Free Savings Account (TFSA). Like Mark wrote about on his site, don’t let the name of the account fool you – there are many great things you can do with your TFSA.
Housing has been a great investment for many Canadians over the last decade but I think you should also invest beyond real estate – for diversification purposes. I know Mark writes about that often via investing in low-cost ETFs.
Lastly, who really has 20% for a down payment? Most people have a difficult enough time scrimping 5% together. On top of that, you’ll need money to cover other housing expenses. Don’t forget about ongoing property taxes, everyday maintenance costs, major renovation expenses over time and more!
Closing thoughts on investing the difference
Thanks to time on Mark’s site today I’ve tried to illustrate the tremendous power that investing over time can deliver. You can invest while paying down your mortgage.
So, whether you choose to invest in TD Bank, or any other established Canadian stock, or an ETF that holds a collection of stocks in an RRSP, TFSA or taxable account – I believe if you can handle any modest rise in mortgage costs you’re better off investing whatever you would have put down as an additional mortgage down payment into some long-term, quality equity investments.
In this low interest rate environment, it might be better to invest any extra money you have than try and kill your mortgage. A lump sum amount invested today has a great chance to grow into something substantial due to the time value of money and the magic of compounding.
I hope your readers consider this approach to build wealth Mark!
Thanks to Gruff for this post and sharing his comments on my site. Now, your turn. What are your thoughts on investing the difference? Do you think this could work for you going-forward? Do tell or share your own investing experiences (while paying down a mortgage) in a comment below.
i believe doing a bit of both is the best , increase your payments by few hundreds$ a month and also invest few hundreds a month , this way you’ll see your mortgage principal going down fast and your investment growing,
I’m sure the money in the market will beat any early payoff for a mortgage but there’s no feeling like the feeling when you pay your last payment and you say wehaaaa i’m done 🙂 i’ve done it twice and now i’m on my third and it works great .
Yes, looking forward to those days to be debt-free as well. A few years out.
Absolutely Gus. My friend Sally decided to put an extra $200 per month into her mortgage. End result was she saved $50K+ on life of the loan saving 9 years of payments. She then put the $1060 monthly into an ETF with a 4% return earning her another $150 K. At age 55 after working 25 years she now has a paid for home probably worth more than she paid for it. Lets say $200 K.
Total assets are now
House $200 K
Bank Stock $550 K (I used todays price) Generates over $25 K annually in dividends
ETF $150 K
She is almost a millionaire. Thanks for the comment.
What a timely post! I was looking into putting 20% down, but I might have to play with my numbers now, it still feels like there’s lots of buying opportunities for dividend stocks.
Do whatever you are comfortable with for sure Jin! Happy investing 🙂
Absolutely our own human nature is working against us. Our emotions overriding the logic. Great point.
I like to think about what if scenarios and what would I do differently. My wife received a few bank stocks as a gift over 20 years ago. After receiving a couple small dividend cheques we turned on the DRIP and left it alone. Result was dividend increased by 385%, # stock held by 133%, stock value by over 700%! We added no further money during this time. Time in the market is so powerful, if we could just stay out of our own way. Won’t tell you about all the decisions and tinkering that cost money, LOL but I at least got that one right.
All the best.
Indeed…just trying to let our DRIPs run and compound away. I recall I wrote the # of DRIPs we’re churning here and will have an update for August.
I’ve made poor decisions as well. Like not buying any Amazon a few years back at $500.
Ah well….I own it via my ETFs.
This is a really interesting idea and one I have not thought of. I like the calculations and logic, but I’m not so sure about the high amount of leverage.
One catch with the plan is that we humans aren’t always logical when it comes to investing. Everyone knows to ‘buy low and sell high’ but most often we do the opposite – we chase the hot stocks, bitcoin, etc. after they’ve already gone up and sell when things go bad/have decreased in value (e.g. March 2009, the market low, more money went out of the stock market than at any other time). While I would like to believe that Sandy kept her money invested in one single stock for 25 years, I don’t think most people could.
I would also argue that for most people making a good wage, the RRSP should be prioritized over the TFSA. If you make less than $50k, go for the TFSA. Ideally, of course, you would do both.
Good points Steve. That’s what struck me really over any 25-year timeline when I talked to Gruff about it during the post. Not many investors have the stomach to stick with any investing plan for 25-years let alone one stock. But the math adds up and I think it’s exactly what Gruff was trying to show – time in the market can be extremely powerful!
Yes, ideally, trying to invest in both right now and have done so – both TFSAs and RRSPs are maxed out. We intend to do the same in 2021. Almost have our TFSA contributions saved up now 🙂
Thanks for your comment!
I think the biggest thing to realize is that most people scrape to even get the 5% down. And most people don’t stay in the same home 25 years! This is a great argument regardless of how much you put down to invest for the long term. The power of compounding interest. Also another really cool point is that most Canadian Bank Stocks pay strong quarterly dividends that can be reinvested into more bank stock that you can use to buy more stock(DRIP). Hence increasing your returns. Our pay cycle is monthly but we pay bi-weekly to make a 13th payment over 12 months(bi weekly works out to be about 26 half payments in 12 months). I’ve been in banking for about 20 years and saw many people lack the discipline to pay down their mortgage. In my world of banking the average mortgage lasted on average about 2 1/2 years before they had to re finance to borrow more to pay of external debt. They spent more then they made. Then the amortization would increase again. Also, collapse the amortization of you’re mortgage!! Don’t leave it at or over 25 years. Nothing goes on the principle. The tipping point when it work in your favour is about 12-14 years remaining on the amortization.
Just a thought on what we aim to do: put aside 5-10% extra each year on the mortgage, 10% income for short term savings, 20+% for long term retirement savings…our mortgage is at about 35% of the value of our home and in the past 5 years we’ve now crossed that line of having more saved then what we owe(not including equity in our home which would be even more!!)… the power of compounding interest does work and once you cross over the peak it looks really cool from here! Goal is early retirement for my wife and for us to be debt free in the next decade!! We’re well on our way!! Good luck friends!!
You seem to have a good balance Boyd = put aside 5-10% extra each year on the mortgage, then 10% income for short term savings, then 20+% for long term retirement savings…
Rinse and repeat for the next couple of decades and you’ll be in a very good place I suspect.
Boyd thanks for your comments. Looks like your well on your way to early retirement. A 30%+ savings rate is amazing.
I think most people like having the balance of paying down debt while putting aside some savings. Nothing wrong with that. When I ask my friends what they would do with a windfall equal to their mortgage, most immediately say pay off/down mortgage. With interest rates so low they don’t understand they are likely better off continuing to pay mortgage and invest the money thus using compound interest and DRIP to their advantage. As interest rates rise they can always apply the investment to the mortgage.
Best of luck. Early retirement rocks.
We ended up putting down 20% on our home. Our perspective was “A Bird in the Hand is Worth Two in the Bush”. I know 6-8% returns are ‘guaranteed’ over the long term, but in the meantime, it’s important to play small ball and find savings where you can. In hindsight, with real estate rising as fast as it has, we would have been better off buying with 5% as early as possible.
Nothing wrong with that approach and you need to do what is best for you! This is just an option or consideration. Choices abound when it comes to personal finance!
How are things overall with you guys?
Things are good! Although, you can definitely see how saving up 20% impacted our portfolio. For a while we had around $200k in cash with barely anything invested. As a result, our registered accounts are way behind where I’d like them to be. Oh well, that’s the trouble with living in a HCOL area..
We all live and learn. You keep maxing out those registered accounts (or striving to, as you well know) and you’ll be golden in the years to come 🙂
Isn’t hindsight wonderful. If I knew then what I know now! Thanks for the comment.
I think the most important thing is to be able to comfortably service any debt and be able to sleep at night.
I recognize this is different form the “5% versus 20%” situation described in the post. A couple of thoughts from my experience and recent thinking. Background – we have a LARGE mortgage (into the 7 figures, well into), a very high marginal tax rate, reasonable equity (30-40%) and 27 years remaining on our amortization although with plans to kill the mortgage around the time of kids heading to College and retirement – each around 20 years from now.
1. I appreciate the advice to pay bimonthly or acccelerated Bi-weekly however for those, like my wife and myself, who only get paid once per month it never made sense to me to have half my mortgage payment come out the day after payday (we got to select this) then have the second half come out mid-month while my residual pay earns peanuts in a checking or savings account. Match pay frequency with payments (we do the same for money destined to be invested).
2. There are few financial plans that shouldn’t have people maximizing their rrsp and fewer still that should not be maximizing their TFSA before contemplating the “invest versus mortgage pay down” question. And having a couple of months expenses set aside.
3. Although this doesn’t apply to those that have decided that paying off their mortgage or low interest debt is their preferred approach for those contemplating investing in a non-registered account while carrying a mortgage their is a combined approach that yields better returns. We have contemplated what to do with the “additional dollar” at the end of the month: Scenario A: As our mortgage currently carries an average rate of 2.84% if that dollar is invested I earn at whatever return is available over the long haul (I estimate 4.5% these days) less personal taxes that take somewhere between 1/2 and 1/4 of those earnings plus pay mortgage interest on the opportunity cost of that dollar at 2.84%.
Scenario B: If used against the mortgage we claim a benefit of not paying interest at 2.84% but also, related to our readvanceable HELOC, can pull that dollar out to our investment account presently at prime-0.25% (today 2.2%) and claim a tax deduction on that interest giving us an effective interest rate of 1.1% today. In this scenario our “costs” are 1.1% (versus the opportunity cost of 2.84% in scenario a) and potential investment gains remain the same (4.5% less tax). Very much like the Smith Maneuver but not automated the same way. This way the decision at the end of every month is the same – make an extra mortgage payment. In time tap some of that equity to accelerate a non-registered series of investments. Achieves the maximum from both situations.
A few comments on your comments!
1. I couldn’t handle the stress of a 7-figure mortgage. I’m glad you can but it’s definitely not for me….
2. I’ve always gone with bi-weekly payments because that is the frequency of my paycheck. If you want to match pay frequency with payments that is OK just know interest is calculated more frequently so the more frequent your payments the less interest you will pay.
3. I’ve always believed in maxing out the TFSA as soon as one can. Then, if you have money leftover, strive to max out RRSP.
4. I am also one that invests in a taxable account so I don’t mind the use of a non-registered account while carrying a mortgage – I’m biased and have done it.
Continued success on investing and killing that monster debt!
Thanks for the great comments Oslerscodes:
As Mark often says, Personal finance is personal and one of the things I admire about his site is his willingness to explore other ideas.
There is more then one way to financial independence. Everyone should be maximizing their TFSA, however I would caution anyone with a DB pension from allowing the RRSP to grow too big. The tax consequences down the line catch some by surprise. Having TFSA, RRSP and Non Registered accounts is best in my opinion allowing for the most options in retirement draw down.
I have no immediate plans to pay off my mortgage even though I’m retired. We use our HELOC as well too grow some other assets. At one point my HELOC was cheaper then my mortgage!
All the best.