Building wealth for retirement or paying off your mortgage faster? How to do both

Most Canadian's have been told its best to pay off their mortgage as soon as possible. This generally means your money earning you less than inflation. Here we look into the opportunity cost of paying off your mortgage rather than investing for retirement as well as how you can achieve both goals at the same time.

How to avoid opportunity cost and maximize your growth

Everyone knows that paying off your mortgage as fast as possible is the right thing to do right?

Sort of…

When you pay down your mortgage you earn a return on your investment (ROI) equal to the interest rate of the debt. At current interest rates most borrowers can expect to save between 2% to 4.5%.

At first this may sound great but lets dig into this a little more.

What is the cost of paying down your mortgage faster?

With inflation numbers reportedly around 6% and arguably even higher this is likely not your best course of action.

So if paying down your mortgage is not the best option what should you do?

Another option could be to index into an S and P 500 exchange traded fund (ETF). Roughly speaking the S and P 500 has averaged over 10% since its inception.

Instead of paying down extra debt on a mortgage an investor could instead put that money into a index fund with the goal of earning a higher return than the cost of their mortgage debt.

Investors often invest in stocks, bonds, residential real estate or commercial real estate.

You should always seek professional advice before investing!

In my experience many would argue this is the better way as it avoids opportunity cost and can lead to long term wealth creation.

But what if you could build long term wealth for retirement and reduce the cost of your mortgage?

I want to be clear, this is not investment advice. I am highlighting a potential strategy that you should research and run by licensed professionals including a chartered professional accountant. I am a Smith Manoeuvre Certified Mortgage (SMCP) Broker and can provide some of the oversight (setting up the mortgage correctly and coordinating with your other experts) but this strategy requires a few professionals. Generally a chartered professional accountant and a financial planner in addition to an experienced mortgage broker. You can learn more about SMCP’s from Robinson Smith here.

Instead of paying down your mortgage to reduce your cost of borrowing by roughly 4% or investing your extra funds to hope to create long term assets you can do both at once.

The first step is some research and planning. This is not something to start doing tomorrow. In my experience most Canadian’s will research this for three to six months before deciding to move forward with the strategy.

What is the Smith Manoeuvre and how can it help you build a better retirement?

That strategy is the Smith Manoeuvre which was developed in the 80’s by Fraser Smith. If you are interested in learning more about the strategy here is a podcast I was on with Robinson Smith, Fraser’s son.

The Smith Manoeuvre allows Canadian’s to eliminate expensive non tax deductible debt and to save for retirement at the same time. If you want to learn some tips to make this strategy more effective check this out.

This is achieved with specific re advancable mortgage products that have two components. A mortgage component and an interest only home equity line of credit (HELOC) component. For every dollar the mortgage is paid down the HELOC grows one dollar (generally up to 65% of the value of your home).

By reducing your non tax deductible mortgage debt and reinvesting the funds in a tax deductible way you are able to reduce your cost of borrowing by your marginal tax rate. For many Canadian’s this can mean a 30 to 44% reduction in your cost of borrowing.

Please note that a HELOC generally costs slightly more than a mortgage. An expert should do the math to gauge the benefit of the debt conversion. There is a strategy called the Fraser Finagle where you convert the HELOC debt back into an amortized mortgage (with the goal of reducing the interest cost back to mortgage levels) while maintaining your tax deductibility.

This strategy can be extremely powerful when combined with accelerated biweekly payments as it can create financial “snowball” using compound growth over a long period of time. If you are investing in real estate learn about the biggest mistake investors make.

There is a ton to cover on this topic, I will write more on this when I have time but I wanted to create a quick intro for everyone who has been responding to my biweekly blog. There are layers to these strategies but I cannot put everything into one post!

Find out more

As mortgage brokers we are on your team. Our job is to understand your needs, plans and wants in order to understand your mortgage needs. We then look at a number of lenders to find the best products and solutions for you.

During our time in the industry we have learned a number of tips and tricks to help you save money and to pay of your mortgage faster.

If you have any questions or would like a customized mortgage plan let us know!

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