In the past, one of the best ways to achieve financial success was by paying down your mortgage as quickly as possible. Mortgage rates used to be much higher (there was a time when they were in double digits), and it wasn’t that long ago when rates hovered around 5% to 6%.
These days, however, the best mortgage rates are much closer to 2%. So why the rush to pay down your mortgage? Don’t get me wrong, paying down your debt is always a good thing, but going all in on real estate is never a good idea. There’s a reason why people say you should never put all your eggs in one basket.
Focusing on investing
Let’s take a look at the math for a second. The major stock index in Canada—the S&P/TSX Composite Index—produced an average annual return of 7.6% over the last 20 years. And mortgage rates are currently around 2%. If historical returns and mortgage rates stay where they are, you could get a pre-tax return of 5.6% (7.6% – 2% = 5.6%) when investing in the market instead of paying down your mortgage.
Of course, it’s never that simple. Markets go up and down so your investments might be up one year but down the next. That’s why some people prefer to pay down their mortgage because they’ll get a guaranteed return.
However, it’s been proven that people who start investing when they’re young end up wealthier later in life. Why is this? Part of it’s due to the power of compounding, but it’s also because many people who have paid off their mortgage don’t always end up saving their extra cash. This doesn’t mean you shouldn’t pay down your mortgage, it just means that you need to be smart about your money.
Peace of mind
There’s no denying that paying down your mortgage is a good thing. For some, it gives them peace of mind that they owe less money—it’s essentially forced savings. Others believe that being mortgage free is a failsafe in case of a job loss since you might not be able to make payments if you still have a mortgage. That’s possible, but that’s why you should always have an emergency fund in place.
Those who prefer to be mortgage free will argue that you could simply rent out a part of your home to bring in some additional cash. Some homeowners may be in a position to do that, but I doubt people who own a single-family home will be willing to rent out a room to a random stranger.
Remember, your mortgage isn’t your only expense. You still have property tax and utility bills to pay. By investing your money, you’re actually more financially secure than having a smaller mortgage since you’ll have other assets to draw from. You can always sell your investments to pay your bills, but trying to refinance your home without a job will be tough.
How you can diversify
If all of your net worth is in your home, you still have the option to refinance your home. Most lenders will allow you to borrow up to 80% of the current value of your home. You can use some of that money and invest it.
This means you’ll have a mortgage again, but at least you won’t have all of your money in real estate. You can use that money are start investing in an RRSP or a TFSA. But understand that you’re borrowing money (from yourself) to invest. This is known as leverage and it can be risky so it’s not for everyone.
Use a mortgage refinance calculator to find out exactly how much equity you could unlock from your home.
The final word
It’s never a bad thing to pay down your mortgage faster, but you want to make sure you’re well diversified. In the current low-interest rate environment, it may make more sense for you to invest instead. Being financially secure comes from having a diversified portfolio of multiple investments, not just a single asset.