Is the mortgage paydown vs investing dilemma different for Canadians?

[c-kat]

Hi All,

I've seen the question of whether it is better to pay down a mortgage or invest debated on here many times. The consensus with today's low interest rates has been to invest. This makes sense to me if you have a U.S. mortgage because my understanding is that you keep your rate for the entire amortization of the mortgage.

Here is Canada, things work differently. Your amortization may be 20 or 25 years but you can's lock in your mortgage rate for that long. A ten year term is the longest I've seen, but most people don't choose it because the rate is so much higher than the 5 year term.

Hubby and I are two years into a five year term on a 25 year mortgage. Our rate is 3.2 but we know it will increase for each term we renew and I am wondering if it would be worth it to repay some some now to protect ourselves against future interest rate hikes. We own two investment properties as well, but they are tax deductible, where as personal residences are not tax deductible in Canada, so should be paid off first. If we put half of what we save each year on the house for the next three years (the other half would continue to go into investments), it will bring our principal down considerably and mean even if rates have gone up, our payment won't. If rates don't end up going up much, we would shorten our amortization on renewal.

Thanks,

c-kat

[KMMK]

My thought is to invest now and as long as you have some investments in non-RRSPs (or even RRSP if you were willing/able to pay the taxes on withdrawal), if the rates are higher when it's renewal time, you can then withdraw some investments and put that towards your principle. There's no reason to pre-pay now with rates so low, and we don't know for sure they'll be higher in 3 years.

I'm 1 year into a 5 yr term at 3.4%. As my investments have been making around 10% over the last two years (higher than average I know) there's no way I'd put any extra into the mortgage right now. It's all going towards investments. I have quite a bit in TFSAs I could pull out in four years if I have to. Also if the rates are higher we may increase our monthly payments to have the total amortization reduced (currently 15 years).

[Catbert]

I think the dilemma is different for Canadians than Americans.  If the mortgage rate can change completely every 5 years with out a specific increase cap then paying down your personal residence makes much more sense than if it was fixed for the life of the loan.  Even more so since you can't deduct the interest. 

OTOH I think that it's harder to get money out of RRSPs before normal retirement age.  That might argue for keeping more money in non-retirement accounts...or (on my 3rd hand) make it even more important to have a paid off house in ER.   

[daverobev]

Hedge it. Being mortgage free is awesome, and having the equity in your house can help on other ways.

Eg, wife bought a rental in the US 'cash' - actually on a LOC. We converted the LOC to a HELOC and then a mortgage on our home. So now we have an extra amount on our house here in Canada at 2.9%, and a house in the US making much more than that.

We're overpaying the 'main' mortgage as much as we can biweekly (ie regular payments are increased). But investing other money also.

[Spudd]

OTOH I think that it's harder to get money out of RRSPs before normal retirement age.  That might argue for keeping more money in non-retirement accounts...or (on my 3rd hand) make it even more important to have a paid off house in ER.   

Why do you think that? My understanding was that it's much easier. I understand that in the US they have restrictions on when they can pull things out from their retirement accounts, but here, we can take out whatever/whenever we want - just need to pay tax on it.

[Tai]

But couldn't you save all the money and then make a lump payment upon renewing if you need to? You don't know how much interest rates will rise, but you'd be losing the difference between what the mortgage interest is at now and whatever return you could get on that money in the meantime. Maybe there is no difference if you're very conservative. I think the prepaying mortgage is either a comfort/security thing or a desire to be completely out of debt for most people.

[Frugancial Advisor]

There is absolutely a big difference in regards to Canadian vs. US mortgage comparison. Our mortgage rates (here in Canada) are normally for 1-5 year terms, which afterwards are then renewed into another 1-5 year term with a brand new interest rate dependent on the future rate environment. We are not guaranteed any rate at renewal time, and therefore are susceptible to rate increases - especially the longer the amortization on the mortgage. Not to mention, it sure doesn't help that our mortgage interest is not tax-deductible.

The circumstances surrounding your mortgage are most important, just as individual risk tolerances and time horizons are so important in your investment decisions, they are also relevant with your mortgage.

Specific considerations include:

-What tax bracket are you in, and what is your available RRSP contribution room?
-How much longer do you have on your mortgage amortization?
-Your mortgage rate is essentially a guaranteed ROI; are you comfortable with the fact that your investment ROI is not guaranteed? (I.e. market may not perform above your mortgage rate in the specific period you have chosen to invest).
-How secure is your future? From a cash flow perspective, having no mortgage can be very relieving vs. early withdrawing from your retirement account and being fully taxed on the withdrawals.
-What are your mortgage prepayment privileges? Most Canadian mortgages have strict limitations on the prepayments you can make, just as registered accounts have limitations on contributions you can make.

All in all, it really comes down to your individual situation and is very hard to make the mortgage vs. invest dilemma so black and white.

One solution I have found that many clients enjoy is paying off the mortgage aggressively, which corresponding increases HELOC room availability which can then be invested in a Non-Registered portfolio with tax-deductible interest. Should rates increase, they have the option to convert their HELOC into a mortgage component of 1-5 years.

[Prairie Stash]

It is different in Canada. I would never touch RRSP to pay down mortgage, the tax penalty isn't worth it. That's what TFSA accounts are for.

Borrowing from a HELOC is the same as buying on margin, it's great when stocks are rising. A HELOC loan on a down market with a drop in house prices is disaster, for a case example see the recent US housing crisis.

Everyone's risk tolerance is different. If you have significant savings you can be more aggressive and max out RRSP now. If you're unable to achieve 18% savings rate (the RRSP max) you might want to build a buffer on the mortgage.

[daverobev]

Borrowing from a HELOC is the same as buying on margin, it's great when stocks are rising. A HELOC loan on a down market with a drop in house prices is disaster, for a case example see the recent US housing crisis.

Not sure about that, if you buy broad index tracking ETFs. House prices coming down are only a problem if you have to sell. Stock prices going down are only a problem if you have to sell.

If you do it sensibly, gradually, and of course not too much, it can be very good.

Of course, if you're impetuous, a day trader or fad-chaser, stay far away.