It’s finally happened. You’ve reached the point where you have some extra cash flow every month. What a feeling!
Now, with your day-to-day expenses covered and your savings plans on track, you’ve got a decision to make: should you use your surplus to pay down your mortgage faster or invest it?
It’s a common dilemma, and the right answer isn’t the same for everyone.
Sure, crunching the numbers can reveal which choice leads to more money at the end of the day.
But your financial situation, goals, and values are also important when deciding what makes the most sense for you.
We often help clients who are grappling with decisions like these. Our focused strategy sessions give them detailed projections and let them clearly see the pros and cons of each choice.
Our process doesn’t just look at the dollars and cents - it’s a holistic approach.
Should You Pay Off Your Mortgage or Invest?
If you’re wondering whether it makes more sense to use your extra cash to pay down your mortgage or invest, here are some key things to factor into your decision:
Mortgage Rate, Balance & Terms
If your mortgage rate is low, investing might yield higher returns, and vice versa.
But if your mortgage balance is high and your amortization is long, you’ll be paying a lot more interest over time. Reducing your principal early in the game can significantly reduce the total amount of interest you’ll pay.
On the other hand, when you don’t have much time remaining and your mortgage balance is lower, it might be tempting to just pay the rest off as quickly as possible. But could you earn significantly more by investing your money instead?
Potential Investment Returns
Look at historical performance for the type of investments you’re considering. Remember to factor in any fees you’re paying when you invest if it’s not the net rate of return, as they will lower your rate of return.
Risk Tolerance
Investing typically offers higher returns but comes with market volatility, while paying down a mortgage is a guaranteed, risk-free return equivalent to your mortgage rate. Which feels right to you?
Time Horizon
The longer you have before you’ll need your savings, the more you can benefit from the compounding effect of investments. When you’re closer to retirement, you may need the money sooner, which could impact your risk tolerance, choice of investments, and rate of return.
Tax Benefits
In Canada, mortgage interest on your primary residence isn’t tax-deductible. Certain investment accounts (like RRSPs or TFSAs in Canada), however, offer significant tax advantages that could influence your decision.
Overall Financial Picture
Your mortgage and investments are just two aspects of your unique financial situation. Other debts, emergency savings, retirement goals, and cash flow projections can influence your choices too.
Economic and Market Conditions
The current economic environment, including interest rates, inflation, and market conditions, could impact both the cost of borrowing and the potential returns on investments.
Personal Goals and Values
Whether you prioritize financial security, wealth accumulation, or lifestyle aspirations, your goals and values can significantly influence your choice.
Is Paying Down Your Mortgage Better Than Investing?
At first glance, paying down your mortgage early can seem like a no-brainer.
After all, it’s a guaranteed return on your money. Every dollar you pay toward your mortgage principal saves you from future interest payments.
But paying off your mortgage faster has opportunity costs. The money used to pay down your mortgage could potentially be growing in investments, offering higher returns than your mortgage’s interest rate.
Is Investing Better Than Reducing Mortgage Debt?
Investing your extra cash could lead to greater wealth accumulation - especially if your mortgage rate is low and you have time to wait out any market volatility. That’s the power of compounding.
For example, if your mortgage rate is 4% but you could earn an average of 8% by investing in a diversified portfolio, the math clearly shows that investing is the better choice.
Here’s some real numbers to illustrate this point.
Let’s say you have a $500,000 mortgage at 4%, amortized over 25 years. If you paid an extra $500 a month, you’d be mortgage free in 19 years, saving yourself 6 years and approximately $77,000 in interest.
Now let’s look at what happens if you invest that $500 every month. Assuming an average return of 8% (less than the historical rate of return for the S&P 500 since inception) you’d have around $266,000 after 19 years. That includes over $150,000 in interest earned - double what you’d save by paying down your mortgage faster.
On the down side, investing comes with inherent risks. Market dips can impact your returns, and there’s no guarantee you’ll achieve the growth you’re aiming for.
How a Financial Planner Can Help
With so many factors to consider, how do you decide between paying down your mortgage and investing? This is where a financial planner can make all the difference.
To help our clients with this kind of decision, we start by understanding your unique situation, goals, and risk tolerance.
Are you more comfortable with the stability of reduced debt?
Or are you drawn to the potential of higher returns through investing?
What are your long-term financial goals—retirement, education savings for your children, a dream vacation?
How does your current financial picture align with these goals?
With the answers to these questions, we create a personalized strategy that balances paying down debt and investing based on your specific circumstances.
We run projections to show you what each scenario might look like, taking into account your mortgage interest rate, potential investment returns, tax implications, and how each option aligns with your values and priorities.
Make Financial Decisions With Confidence
Bottom line: if you’re feeling unsure about where to direct your savings, you’re not alone.
A focused strategy session with a Certified Financial Planner (like us!) can help you see the bigger picture and ultimately make the best decision for YOUR life.
Ready to explore your options? Book a call today.