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.
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.