Should You Be Paying Your Mortgage Down Aggressively?
Last year a third of mortgage holders in Canada chose to pay their mortgages aggressively, which is to say they paid more than the amount required. And the numbers were higher for those who bought their properties after 2013.
Instinctively it would make sense to pay off your mortgage as quickly as you can, to reduce your debt and to build up more equity in your home in case you wanted to borrow against it.
But this isn’t always the case.
When does paying your mortgage aggressively make sense?
Canwise Financial President James Laird identified three kinds of people for whom an aggressive payment plan would be prudent.
The first are people who have mortgages with a high interest rate, since any additional payments (also known as prepayments) go towards reducing the principal. This will lower payments faster and puts you in a better negotiating position when the time comes to refinance.
The second kind are people with access to a Home Equity Line of Credit (HELOC), which can be used as their emergency fund. In that case, the money you’d otherwise put away for unexpected purchases might as well go towards your mortgage.
The third group are people uncomfortable with other investment vehicles like stocks and bonds. The big positive to paying a mortgage down aggressively is that it entails zero risk. And it’s better than letting the money sit under the mattress.
Renee Dadswell, Mortgage Trainer at Mortgage Professionals Canada and a mortgage agent at The Mortgage Station, added one more category of people well-suited to aggressively paying down their mortgage: those with refinanced mortgages where the money was used to purchase items with a shorter lifespan, like a car. “You don’t want to be paying for the car 15 or 20 years later when you don’t even own it anymore,” says Dadswell.
When does paying your mortgage aggressively not make sense?
“If you have a super low rate, don’t rush to pay it back,” Laird recommends. “It’s cheap money. Take advantage of it.”
Another instance where paying a mortgage down aggressively would be unwise is when the property in question is a rental property or houses a home-based business. “A portion of the interest (on rental properties and homes with home offices) are tax deductible,” says Dadswell. “In these cases, aggressive payback could have very negative tax effects.”
A third argument against an aggressive mortgage payback plan is if you can find another investment that gives you a better return. “If you put $100,000 into your 3.00% mortgage, you save $3,000 next year,” says Laird. “If you made a 5% return on that $100K instead, you could put that $3K towards your mortgage next year and still have $2K left over.”
How could you pay your mortgage more aggressively?
Like with anything else, how your money goes out should be a function of how it comes in.
If you’re a salaried employee and just got a significant pay raise, you could choose to increase your regular payments and direct that extra money towards the principal.
If your extra money comes to you as a year-end bonus or an owner’s dividend, you could choose to make a yearly lump-sum payment towards the principal.
Note that many full-featured mortgages come with flexible prepayment options that allow the borrower to increase their monthly payments by up to 100%, and allow for annual lump sum payments of up to 25% (though typically between 10-20%).
Either way, Dadswell offers this word of caution: “The goal of living in a house is to enjoy it and make memories in this home. If your budget is so tight that you cannot enjoy the house as a home, you will regret the purchase,” she said.
“A mortgage will most likely be your largest debt,” says Laird. “The payment schedule will inform the rest of your financial life, from your monthly budget to RRSP/RESP planning to how much you can save.”
Both Laird and Dadswell agree that a consultation with a mortgage broker and your financial planner should happen before putting an aggressive mortgage payback plan in place.
“You’ll get the right perspective on your goals and how putting more towards your mortgage will impact those goals,” says Laird.
And when you’re contemplating having less money in your pocket at the end of the month or year, the right perspective is a good thing.