Paying off your mortgage faster provides the best bang for the investment dollar, according to financial analysts – and the shorter the amortization the better.
“In a nutshell, on a risk-adjusted after-tax basis, paying down your mortgage is one of the best uses of money in general,” said Rob McLister, a mortgage broker and editor of CanadianMortgageTrends.com.
However, exceptions exist.
Paying off high-cost debt is still the best first option, McLister said. But with the historically low mortgage rates in Canada, prepaying a mortgage can provide a greater return than many other available investments.
For example, McLister said, a Canadian in a 40 per cent tax bracket would get a 6.15 per cent after-tax return from prepaying a mortgage with a competitive 3.69 per cent rate. That is far better than what is offered by most non-registered investments.
Moreover, McLister noted, paying down the mortgage is virtually risk free, while most other investments aren’t. Because interest is compounded, the earlier in the term the lump-sum payment is made, the better.
However, few Canadians actually make mortgage prepayments. The Canadian Association of Accredited Mortgage Professionals fall 2010 survey showed that 12 per cent of mortgage holders (or about 650,000 Canadians) made lump-sum payments on their mortgage last year. Another 16 per cent (or 925,000 people) increased the amount of their monthly payments, and only 7 per cent (or 375,000 people) did both (about 5.65 million Canadians have mortgages). The average lump-sum payment was only 1 per cent of the outstanding mortgage amount. But even small payments have a multiplier effect.
A homeowner with a $300,000 mortgage and a 35-year amortization, for example, could save $71,000 over the life of the mortgage if he or she moved to an accelerated weekly payment from a monthly payment. Taking a 25-year term rather than a 35-year term can save up to $90,000. Cutting the term to 25 years from 30 years cuts $53,000 in interest and costs only $84 a month extra.
It also helps to put the biggest down payment possible on any mortgage. A homeowner who puts only 5 per cent down on a $300,000 house and pays a fixed rate of 5 per cent over a 35-year amortization term will pay C$325,000 in interest–effectively doubling the cost of the home. That compares to $265,000 in interest for those who make a 20 per cent down payment.