Tuesday, April 03, 2007

Mortgage vs Investing Debate...Again

Well with Money Diva's comment yesterday and MCM topic idea for the 100th post contest (by the way today is the last day to enter to win a $25 gift card to Chapter's book store) I've decided to touch on the entire mortgage versus investing debate again (for round #1 see here).

The overall debate goes like this. You have two compounding curves fighting each other in this case. Your mortgage is a negative compounding curve while investing is a positive compounding curve. In either case, they are both great ideas to put your money since they are compounding. Yet each way has some different factors to consider.

On the mortgage side, if you put your money here:
- You get your mortgage interest rate as a after tax rate of return in savings on your mortgage interest you pay
- This rate or savings, unlike any stock, will be there for the entire length of your mortgage guaranteed
-Paying off the mortgage will ensure you need less of a cash flow in retirement
-If you sell your house you can take any gains you make tax free (if it is your principle residence)
-Paying the mortgage off sooner works better in the beginning of the mortgage because you get the compounding savings over a longer period of time

On the investing side, if you put your money here:
-Over a long period of time you can on average get a higher rate of return with stocks over the current mortgage rates
-Yet you will be taxed on that rate of return regardless if it is in an RRSP or not (in the RRSP you just get to defer it and hopefully get taxed at a lower rate when you pull it out, but it still gets taxed. An exception to this is low income earners who collect dividends outside of an RRSP, but they will still be taxed on capital gains if they ever sell the stock.)
-If you borrow money to invest outside an RRSP you can deduct the interest from your taxes
-Investing earlier will make compounding work more for you with more time

So with a debate like this it is easy to get confused just with the number of variables involved. Yet let's take a step back here and think about the points I wrote above. Is it me or does the mortgage side seem to have a lot less risk involved? Also remember your savings will be on a after tax basis and if it is on your principle residence you can sell it in the future tax free, so even on a tax basis it looks good.

With all that in mind here is my two cents. In general (this doesn't apply to every case), you are better off to spend the money by paying off the mortgage on your principle residence to a point. You want to ensure you pay it off faster in the first five years for the biggest impact on your overall financial health. Then keep paying it off faster until you are sure the remaining amount will be fully paid off by the time you retire. After that point you can switch over to buying RRSP's and hopefully get a bigger bang for your RRSP tax break since you have put this off for at least five years and now have a higher salary.

Well that's my latest idea on the entire debate, what do you think?

7 comments:

Monty Loree said...

Wow!!
Another personal finance blogger from Regina!! Small world.

I saw you comment on Cajunman's blog and thought I would drop by.

I am hosting the first ever Canadian Tour of Personal Finance blogs over at http://www.canadian-money-advisor.ca

Let me know if you're interested to join in.

Cheers,

Monty Loree

Canadian Money said...

One suggestion I recall - is to put extra money into an RRSP, then put the tax refund towards the mortgage.

the money diva said...

CD,
What about the value of leverage? If you leave your mortgage high then the investment value of that money is multipled many times over. It's almost the only situation in which ordinary people get leveraged investment returns.
MD

Canadian Dream said...

Monty,

A very small web some days. Drop me an email and I'll discuss it with you (candian.dream.free.at.45@gmail.com).

CM,

That would be a good idea if your in a high tax bracket already. It isn't as great as you drop down.

MD,

Leverage is a difficult one to deal with. Yes if you pay down the mortgage and then take it back out as an investment loan you can increase your earnings, but then there is the risk your money tanks in the market and you are still paying off the loan. To pull it off you need a great deal of confidence in your investment choices and the ability to stick with the strategy for a ten year window. It can work, but you have to be the right kind of person to pull it off.

CD

Middle Class Millionaire said...

Hi CD,

Thanks for writing on my suggestion.

I don’t think there is a right or wrong strategy when it comes to mortgage vs. investing. I think the right answer depends on the individual and their unique situation, lifestyle, investing strategy etc... My view on the issue is different from yours (investing before mortgage) which is good because after I post on the subject I’ll link readers back to here so they can compare points of view.

Cheers,
MCM

Canadian Dream said...

MCM,

I agree there is no one right answer. I just tried to provide a general idea based on my experience. I would like to see your post when you get it done. Please leave a link.

CD

Savings Journey said...

For me I wouldn't consider it a versus - a home is just another type of investment. If you have the extra bucks I would suggest investing extra in both your home and your investments, and investing any tax returns that you get in either.

Since everyone's situations, timelines and goals are unique then there's no one simple answer to this. Personally I think it's a moot debate because wise investors always diversify!