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The pursuit of mortgage freedom for many Canadians is still the ultimate dream. After all, how satisfying would it be to own your home outright and not have to look at the bank taking some of your money every month? However, this goal of aggressively paying down the principal on your mortgage may not always represent the best use of your money. The landscape of your personal finances stretches far beyond just a one lane highway where all you get is a home at the end and nothing else along the way. There is more available to you if you would be willing to stretch yourself and seek greater returns than the modest interest savings you get from prepaying your mortgage. I’m writing today with the hopes of opening the door of opportunity in your life and give you a strategic approach to managing your income and exploring options that could elevate your financial picture moving forward.
Exploring Alternatives to Mortgage Prepayments
Before you decide to funnel extra cash into your mortgage, consider the many alternatives that could serve you better in the long run. Here are some examples:
High-Interest Debt: Paying off credit cards or loans with steep interest rates takes precedence, offering immediate and substantial savings. With most interest payments at or above 20% interest, it is clear that your money is better spent clearing this debt than diverting that money to paying of a mortgage that is likely sitting somewhere between 4-6% interest.
Investment Properties: This avenue offers the allure of generating additional income streams and diversifying your investment portfolio.
Retirement Savings: Contributions to a Registered Retirement Savings Plan (RRSP) not only prepare you for a comfortable retirement, but also reduce your taxable income that will provide you with immediate financial relief.
Tax-Free Savings: Should you get to a point where you have maxed out your RRSP, a Tax-Free Savings Account (TFSA) becomes an attractive option for growing your investments tax-free.
Educational Investments: Contributing to a Registered Education Savings Plan (RESP) supports future educational aspirations while availing of government grants.
Time is Money: A Longer Mortgage for Greater Wealth
Extending your mortgage term can ironically lead to greater financial wealth. By opting for a longer amortization period, you free up cash that can be invested in higher-yielding opportunities. The plan and hope is that as your income grows over time, the relative burden of your mortgage decreases, allowing you to capitalize on the appreciation of your investments.
The Value of Flexibility
Access to liquid assets in times of financial uncertainty cannot be understated. When you pay down the principal on your home with additional mortgage payments, you have locked that financial asset up until you sell or refinance your home. Liquid investments can be quickly converted to cash. Now more than ever we live in a time of uncertainty, and liquid assets will always be helpful to have should you ever encounter unforeseen financial difficulties.
Looking at Debt in a Whole New Light
The notion that all debt is inherently bad is a misconception that can hinder your financial progress. By understanding how to use debt as a tool for leveraging opportunities, you can significantly enhance your financial picture. It’s about strategic borrowing—taking on debt for the right reasons, with a clear plan for repayment and a realistic assessment of the risks involved. Let’s look at just some ways you can leverage debt:
Leveraging the Power of Mortgages
Purchasing a home with a mortgage allows you to leverage a small amount of your own money (the down payment) to control a valuable asset—the home itself. Over time, as you pay down the mortgage and hopefully the value of the property increases, the equity you have in your home grows. This is a clear example of using debt to create a pathway to wealth that would be difficult to achieve otherwise.
Investment Potential of a HELOC
A Home Equity Line of Credit (HELOC) allows homeowners to borrow against the equity in their home at relatively low interest rates. This can be a powerful way to use debt strategically. For example, using a HELOC to invest in additional properties can expand your asset base and income through rental earnings. Alternatively, it could fund renovations that increase your home’s value. Both scenarios use debt to potentially increase your net worth.
Debt for Education: An Investment in Future Earnings
Investing in education is another strategic use of debt. Whether it's pursuing further education yourself or funding a child’s education through a loan, the long-term benefits can far outweigh the initial debt. Higher education often leads to higher earning potential, which improves your financial situation over time. The key here is to see education as an investment in future earnings, with the debt as the vehicle that makes this investment possible.
Business Loans: Financing Your Growth
For entrepreneurial homeowners, taking on debt to start or grow a business can be a calculated risk with high rewards. A business loan can provide the capital needed to scale operations, purchase inventory, or expand marketing efforts. When a business grows, it not only increases income but also adds to your assets, enhancing your financial picture.
#1 PLACE WE PUT OUR MONEY
Being in real estate, our entire team believes real estate is the best investment you can make, and we have each seen individual gain from owning rental (investment) properties. With a bit of up front cash, you can turn an extremely unaffordable product (a house) into an owned asset that will be paid off (if you do it right) by your tenant. Let’s look at an example:
If I buy a bungalow for $550,000 and convert it into a duplex (so adding a legal suite to the basement), the numbers would roughly be as follows: Money I NEED to have: $110,000 (20% of $550,000) + $125,000 renovation costs (for adding the basement suite). That is a total of $225,000. Lets add in another $25,000 to cover land transfer tax, lawyer fees and unexpected set backs.
Seems like a lot of money, but if we calculate that our tenant will pay for the remaining balance of the mortgage, we have just gained an asset worth $550,000 while only paying $250,000 to get it. Not bad… But there is more! If you hold onto this asset for the 25-30 years that a mortgage runs, it is guaranteed to appreciate in value over that amount of time. So it gains even more value just through the time you own it.
To top things off, this rental property once it has been paid off will make you A LOT of money every month if/when you retire. Duplexes could get you somewhere in the range of $2,000-$3,500 per month (in your pocket) when fully paid off. If you have more than one rental property, that’s a good chunk of change that will service quite well as a “retirement income”.
It’s definitely something to think about. Many of you have owned a home for a long time and have no mortgage or a very small one. Although having next to no debt feels good, you are always open to finding more ways to grow your wealth to be financially secure moving into your future. This is one great avenue to do that!
CONCLUSION
As we can clearly see, strategically leveraging debt can lead to a much brighter future for you and your family. While the safety and guaranteed return of mortgage prepayments are appealing, they come with the downside of reduced liquidity and opportunity cost. For those nearing retirement, or with a preference for financial security over higher returns, prepaying a mortgage may still be a viable strategy. The key is to maintain a balance, ensuring you have a safety net of liquid assets. I would strongly suggest consulting with a financial adviser to offer clarity and set you up on the path to success that is right for you. Not all debt is good, but it can be a strategic tool that, when used wisely, can help you build wealth, increase assets, and secure a better financial future.
