When you get extra cash due to a raise or bonus, you might ask yourself: "Should I use this to pay off my mortgage faster or invest this money?" It's a difficult choice to make, especially when your mortgage is still years away from being fully paid. On the other hand, whether it's for passive income or a hefty retirement life, investments ensure that you have money in the future. As such, the answer is not as simple as you think.
However, with the right insight, you can very likely arrive at your own financial decisions. Here's what you need to know.
Optically, It Seems Better To Pay Your Mortgage Early
We know we said the answer isn't very straightforward, but there is indeed an objective answer. Think of mortgages as fixed investment. That investment is in a property. You can always calculate precisely how much mortgage is outstanding, depending on when you put the money in, the mortgage's interest rate, and term.
For example, if your mortgage balance is $400,000 on a 30-year amortization with an interest rate of 5.84%, then 15 years into it, you'd have a remaining balance of $282,221.
However, because it's interest-based, the sooner you pay off the mortgage, the less you can pay in the long run. So, let's say that you can pay this $400,000 in 15 years, then you won't have to pay for the 5.84% compound interest in the succeeding ones.
How can I pay my mortgage quickly?
There are a lot of options for those who want to pay off the mortgage faster. Here are some of the most common ones:
- Lump-sum payments. Most lenders will allow for additional "lump-sum" during the term, which are large payments made in one go. You could make additional payments as little as $100 and up to 20% of the principal amount, depending on the lender.
- Double-up payments. As its name suggests, these are payments that are double the usual amount. So, if you typically paid a monthly mortgage of $3,000, doubling up will allow you to send over $6,000 instead.
- Renewal payments. Banks and other lenders will allow you to renew your mortgage before it matures. At this time, the mortgage is open, and you are allowed to pay any amount that you want to reduce the principle as much as you wish.
Of course, not all of these will be available to you. Check your contract to see your options.
An Investment Can Provide Better Returns Over The Long Term
Again, while paying down your mortgage is important, you should not forget to invest. In an article on the Financial Post, in collaboration with StackCommerce, professionals gave good reasons why you should invest—and why you should do so early. For example, shares will generally grow bigger the longer they're invested in them.
But how do you generate the extra money needed to invest? The answer is to refinance. There is a strategy called the "Smith Maneouvre" that you can utilize as a Canadian to turn some of your mortgage's non-tax deductable debt to tax deductable debt.
Here is a quick video that I created that explains what the Smith Maneouvre is:
Setting up your mortgage properly with the Smith Manouevre requires a specific type of mortgage. It's also important to work with an accountant and financial professional who can make sure everything is set up properly for you.
Most clients want to invest, but aren't aware of the Smith Manouevre first ask about a mortgage refinance...
What is refinancing?
A mortgage refinance is when you get another lender to pay part of the mortgage for you (usually up to 80% of its current value) and you pay the second lender at a lowered interest.
In fact, we mentioned how one great thing about mortgages is how its fees can be computed based on their current values and interest. If you set aside a savings pool to pay off that remaining 20% or so, then you can completely close the mortgage upon refinancing and focus your efforts on paying off the smaller loan.
But not everybody qualifies for a mortgage refinance. This is only available for people whose mortgage fees (including utilities) don't exceed 39% of their gross income.
How do I invest while juggling a Loan or Mortgage?
Before you can start investing, you need to open a brokerage account. To get the most out of your money, open up an online brokerage account so you don't need to pay a financial planner to invest for you.
However, having an online brokerage entails doing your own research and creating your own portfolio; the risk is also much higher unless you genuinely know what you're doing.
Fortunately, if you invest long-term, you gain money as long as you invest in profiting stocks. The trick is to find a business that is still going to be around in the next ten years (and thriving) like, let's say, the Royal Bank of Canada or CargoJet. You're guaranteed to make a profit, although it won't be a huge margin due to the low risk.
Plus, with a do-it-yourself portfolio, there's no pressure to pool in large amounts (nor any money, really) if you have nothing extra for the month.
The sooner you get the mortgage off your hands, the better. You can either do this by paying your fees early. If this option is too much for your salary, then consider refinancing—or getting another lender to pay for your loan before paying that entity the remaining fee at a lowered interest. This will help ease your monthly bills, allowing you to invest a portion of your money.
If your goal is a comfortable, debt-free life upon retirement, then it's important to prioritize both.