Every other person is motivated to be debt free. In this pursuit, a question begs to be answered: Do I pay down my mortgage or save for my retirement?
Unfortunately there is a lot of noise on this issue leaving the population with a lot of fog and mist to navigate through.
We pay our mortgages with after tax income. A typical mortgage, now a days carries an interest rate of 2-5%. When we make extra principle payments, our saving is that interest rate. 2-5% !
Now, consider this: We typically pay 33-45% tax on our income and then apply it to save this above mentioned interest.
Paying 45% tax to save 5% rate does not go down well with any hard working prudent person.
Moreover, if invested in a moderate investment option, we can expect a long term tax sheltered returns of 6% or more.
Let us talk in numbers. A mortgage of $350,000 @ 3.5% will need extra $278/month to reduce amortization from 25 years to 20 years.
If this money is invested in retirement savings (RRSP) at 6%, it will amount to $193,600 by the end of 25 years. There will be additional $37,530 in tax refunds at marginal tax rate of 45% ($27,522 @33% tax rate).
All this by taking extra 5 years to pay down your mortgage!
It is time to recognize the friend we have in a mortgage, a leverage tool. Instead of getting rid of it, it is more valuable to consider in terms of where do I put my finite dollars for maximum benefit. Answer lies in assessing your personal situation and seeing what it costs us in terms of opportunity.
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valid point. but one also needs to take into a/c whether the mortgage is on a property they plan to sell or settle into. If you have the money and plan to settle in the said house, might as well get out of debt!
ReplyDeleteGood post.
ReplyDeleteBut what I am unable to understand here is, if I take extra 5 years to pay down my mortgage, doesn't my rate of interest increase?
Another question- what is the lock-in period of a retirement savings plan?
KS:
ReplyDeleteIt doesn't matter weather you settle in, rent or sell the house. The value of the house is independent of the borrowing on it. Any payment on the principal is coming out of your after tax income. Tax saved is usually about 10 times more beneficial that any interest savings.
KY:
rate of interest is independent of the amortization. You may carry a small portion of the mortgage for extra time and will have interest expense on it. When compared to savings, growth and tax refunds, you will gladly pay 10 cents on interest to get $1 or $1.5 back