Is it OK to Pay Off Your Mortgage before Saving for Retirement?
Many financial advisors would say you shouldn’t defer saving for retirement to pay off your mortgage first. However, the truth is that paying off your mortgage first can be a perfectly sensible strategy as long as some important conditions are met.
The main condition you need to meet is that you are saving for the long term in some form. This should be at least 10% of your take home pay directed to long-term savings, preferably more. Commissioned financial advisors can make money if your savings are in the form of RRSP or TFSA contributions, but making extra payments against your mortgage can work for you as well.
Note that I said “extra” mortgage payments. It’s no good to save nothing in an RRSP or TFSA and just make your regular mortgage payments for 25 years. That’s just using your mortgage as an excuse to overspend right now.
Suppose your family take-home pay is $70,000. Then if you’re going to defer making RRSP or TFSA contributions, you should be paying at least $7000 extra each year against your mortgage. This will pay off your mortgage many years early. Then you can aggressively build RRSP and/or TFSA savings.
Another condition you have to meet for this strategy to make sense is to avoid building up other debts. If you’re paying extra on your mortgage but building debt on your lines of credit, credit cards, or with car loans, you’re not really saving. This applies to RRSP and TFSA savings as well; if you’re building debt at the same time, you’re not making any progress.
Most financial projections will show that you’re better off making RRSP and TFSA contributions early on instead of paying off your mortgage aggressively. However, the difference isn’t huge. What really matters is the amount you’re saving. If you save enough, you’ll benefit whether you save this money in an investment account or use it to reduce your mortgage.
The main condition you need to meet is that you are saving for the long term in some form. This should be at least 10% of your take home pay directed to long-term savings, preferably more. Commissioned financial advisors can make money if your savings are in the form of RRSP or TFSA contributions, but making extra payments against your mortgage can work for you as well.
Note that I said “extra” mortgage payments. It’s no good to save nothing in an RRSP or TFSA and just make your regular mortgage payments for 25 years. That’s just using your mortgage as an excuse to overspend right now.
Suppose your family take-home pay is $70,000. Then if you’re going to defer making RRSP or TFSA contributions, you should be paying at least $7000 extra each year against your mortgage. This will pay off your mortgage many years early. Then you can aggressively build RRSP and/or TFSA savings.
Another condition you have to meet for this strategy to make sense is to avoid building up other debts. If you’re paying extra on your mortgage but building debt on your lines of credit, credit cards, or with car loans, you’re not really saving. This applies to RRSP and TFSA savings as well; if you’re building debt at the same time, you’re not making any progress.
Most financial projections will show that you’re better off making RRSP and TFSA contributions early on instead of paying off your mortgage aggressively. However, the difference isn’t huge. What really matters is the amount you’re saving. If you save enough, you’ll benefit whether you save this money in an investment account or use it to reduce your mortgage.
I noticed you offered a caution about HELOCs and that seems very timely. I wonder how many people have "paid off" their mortgage but have $45-70k in HELOC debt?
ReplyDeleteThe classic compromise of contribute to your RRSP and use the refund for the mortgage might help avoid that a bit. But then I've read there's a huge number of people who withdraw from their RRSPs to pay down consumer debt, so who knows.
I'm beginning to wonder if an increased mandatory pension plan (e.g. expanded CPP or something) might be the only solution. Everyone screamed the last time CPP premiums were raised significantly but I notice most of us are still working and few companies actually collapsed because of it.
@BetCrooks: You're right that savings mean nothing if you're building debt beside them. Rather than expand CPP, I'd rather see benefits start later and be larger. I.e., no change in the total value, just larger payments starting later in life.
DeleteEverthing is relative to each person's situation.
ReplyDeleteMy house is paid off and I max out the RRSP and TFSA every year.
So I have a HELOC to purchase dividend paying stocks in a non-registered account. As long as the dividends pay the HELOC interest as well as pay down the principal every month I figure I am ahead of the game. Have grown this to 130K with 90K HELOC so the dividends are getting substantial. Yes I do have to pay some tax on the divs but as my HELOC interest is tax deductible it is not too much. Now if interest rates increase that may change things but the outlook is for another year of low interest rates.
A few caveats: 1) You may be able to get a "free" HELOC to start but there are usually closure fees (lawyer/notarial fees,etc) when you do close it down. Make sure you discuss ALL the fine print and costs with the institution. So that detracts somewhat from your profits. If you have held it for long enough, several years, it becomes minor. 2) Pick stocks that increase in value not decrease in value. LOL. Remember that there will still be fluctuations in value so if you are subject to stomach butterflies this may not be for you. Obviously if you are paying 3% interest on the HELOC (what I pay) you will want stocks that pay in the 5-6% range to be able to make anything off of this. So if you get 6% interest and the HELOC costs you 3% then you get to pay taxes at whatever your income tax bracket is on the remainder. Obviously at the start you will not be making all that much but compounding dividends grow fairly fast. Each month will reduce your principle so the next month there are more divs to pay down the HELOC and therefore less interest. And eventually you buy another "winning" stock, hopefully and it goes even faster.
@Anonymous: The most important part of what you said is that you max out your RRSP and TFSA every year. This means you have assets to draw upon to pay off your HELOC if your dividend stocks take another dive like they did in 2008-2009.
DeleteThe combination of leverage and stock picking certainly increases risk substantially. I wouldn't recommend your strategy to most people.
Why is the interest on your HELOC tax-deductible? Is it because you are using the finds from your LOC to invest in CDN complanies?
Delete@Robin: I assume that the HELOC was opened and the borrowed money was used to invest. This straight-line link seems to be required by CRA for the interest to be deductible.
Delete@ MJ - I go the other way on the CPP - I'd rather get paid less sooner, than more later. There's no guarantees on longevity in this world, just ask Jim Flaherty.
ReplyDeletePersonally I think the debate between extra money on the rrsp or extra money on the mortgage speaks to one's sense of security. My wife and I both have very corporate jobs and are survivors of multiple layoffs... if our house were fully paid off I'd sleep better at night knowing our lives could go on fairly the same if one of us couldn't find work for over a year (our current emergency fund would cover us that first year). The future is hard to predict.
@Anonymous: I think most people would agree with you about getting CPP sooner. Then many would find that they can't afford to live on the tiny payments. My preference for larger payments later isn't so much a preference for my own personal situation, but a prescription for helping out the masses who have no realistic hope of having enough money to retire at 65 or sooner.
DeleteWhen I was younger I definitely felt better about paying down my mortgage. As long as you're paying it down at an acceptable pace, deferring retirement saving is reasonable.