Mortgage Paydown Overtakes Investing

The #1 financial priority for people with a mortgage is, you guessed it, paying down their mortgage.

42% of Canadians with mortgages say that is their top money goal, according to Manulife Bank’s latest Canadian Debt Survey. And it’s a number that may rise.

Fuelling the Trend

The urgency to become mortgage-free could intensify further over time, for several reasons:

1. Mortgage Balances Have Grown: Mortgage balances are larger than ever, at almost $210,000 on average, according to CMHC. And they’ve been growing faster than incomes. For newly originated mortgages, balances are 26% above average at $264,000.
2. Longer Amortizations: Not only are mortgages bigger, but people are carrying them longer. CD Howe found that 34.5% of pre-retirees aged 55-64 had a mortgage as of the last census (2016) versus just 25.1% in 1999. And mortgage amounts were almost double for this age bracket ($130,000 in 2016 vs. $67,400 in 1999).
3. Relative Returns: Falling investment yields are shifting people’s priorities. In 1999, five-year GICs paid almost 6.0%. Today, the best are under 3%. When compared to today’s average mortgage rate of almost 3%, the safe, tax-free return from paying down a mortgage doesn’t look too bad. For someone with $100,000 in taxable income, prepaying a 3% mortgage is like earning almost 5% before tax with virtually zero principal risk.
4. Slowing Savings: Savings rates are near all-time lows and more people are approaching retirement with insufficient assets. Case in point: the median retirement assets for those in their peak savings years (age 55 to 64) was just over $3,000 a few years ago. Fewer than one in five 55- to 64-year-olds without pensions have 5+ years of living expenses saved. It’s no wonder that those in the 65+ age group have had the highest mortgage arrears since 2015. Older undersavers simply cannot stomach investing risk and are compelled to slash shelter expenses. That increases the appeal of mortgage prepayments over RRSP/TFSA contributions. Side note: The “household savings rate” is far from perfect, but it does approximate the general trend.
5. The Nest is the Nest Egg: A paid-off house lets the homeowner tap equity to survive (via a mortgage, HELOC or reverse mortgage). What’s more, Canada’s principal residence exemption lets one sell and cash out tax-free, something you can’t do with regular investments. More than 1 in 4 Canadians admit to relying on their home equity to fund their retirement, and that number has continued to rise. This increasing reliance on home equity has been further supported by Canada’s robust real estate market, falling investment returns and higher debt loads.
6. Ease: Making a mortgage prepayment is easy if you have the money. Investing—at least successful investing—is harder, requiring significant research and/or trust in a third-party advisor (which entails fees). With a society increasingly plagued by attention deficit, more borrowers could be prone to simply slapping extra cash on their mortgage.
7. Media & Psychology:  Never before has debt risk been so prominent. Record debt loads are constant fodder for the media. An unquantifiable number of us are trying to avoid being “one of those people,” the “foolishly” over-indebted. Owning a home with no payments lowers one’s risk if there’s an income loss. That breeds confidence and arguably has greater physic benefits in this day and age — yet another potential reason to pay down one’s mortgage.

Investing in the Market vs. Your Mortgage

Only 31% of mortgagors told Manulife that “saving for retirement” was their top financial mission. But those who shun investing to whittle down their mortgage face potential opportunity costs.

Here are just some of the reasons to consider investing over paying down your mortgage:

1. Better Returns: For risk-tolerant borrowers with ample time horizons, tax-deferred investing generally has a long-term edge over mortgage prepayments. Despite tax-adjusted returns of up to 5% on today’s mortgages, disciplined growth-style investors should expect to earn more: about 6.5% over the long run (+/- 1%), estimates Edward Jones, albeit with more volatility. Such returns can accumulate tax-free in a registered account. These temporary tax shelters are extra important if your tax bracket is high.
2. Your Job is Stable:  Other things equal, if the risk of income loss is low, there’s less urgency to eliminate one’s monthly mortgage payments.
3. You’re young enough to make back losses:  If you’re more than 10-15 years away from retirement, a 5% return may not be sufficient to help you retire comfortably. Trading more investment risk for greater reward is usually worth it.
4. Liquidity: If home prices dive, so does your equity. Investment products offer more liquidity if the borrower ever loses their job, gets seriously ill or encounters other life challenges. Worst case, investments (even RRSPs) can be turned into cash. It’s not as easy, by comparison, to tap home equity when adversity strikes. That is, unless you’ve set up a HELOC in advance.
5. Diversification: Don’t let the last few decades fool you. Home prices aren’t always a one-way street. A 20% drop in home value may not be probable, but it’s always possible. And price corrections are all the more painful when you have income interruption and/or minimal non-housing assets to fall back on.

The Takeaway

There’s no one single approach to financial planning. Your best strategy hinges on your personal balance sheet, employment, risk tolerance and return assumptions.

That said, if you want a quick and dirty comparison of mortgage prepayments vs. investing, Sun Life has this calculator. Assuming your finances aren’t too complex, give it a whirl and see what it recommends. (You’ll need to know your marginal tax rate, so here’s a calculator to estimate it.)

Of course, sometimes people have other priorities besides improving their personal balance sheet. In fact, 27% say their #1 financial goal is “saving for my next vacation.” So regardless of whether you accelerate your mortgage or invest, you can take solace that while the vacationers are enjoying tours and beaches in the short-term, you’re building your net worth for the long term.

Sidebar: Allocating more cash to a mortgage than one’s retirement savings isn’t the only way to save. 83% of Canadians with mortgages have non-mortgage debt as well. To the extent this debt is high interest (e.g., 8%+), extra mortgage payments and retirement saving should generally take a back seat to paying off non-mortgage debt.