Episode 49 – Pay Down Your Mortgage or Top Up Your TFSA?
Pay off your mortgage early or add to your TFSA? There is no right or wrong answer! The best option for you actually depends on many factors such as…
- Excess spending money
- Retirement date
In episode 49 of the Heart of Your Money podcast, I explain a few different scenarios and help you determine what the best bang for your buck is!
Hey there, welcome back. This week, I want to talk about a question that I received. They asked this question, “should I pay down my mortgage or top up my TFSA?” These listeners had two completely different scenarios, and of course, there’s a bit of a different answer for each of them. I know you hate that but think age, excess, retirement dates, et cetera, you name it – all different facts for each of them.
But I want to share some general thoughts that will still apply to everyone, and they’re common in all scenarios – so I am going to give you an answer. It’s a little bit general – you’ll have to do your own digging and, you know, meet with your planner and go through it and be patient. But this is going to really guide you there.
Something to remember – so here’s a note with today’s question of tax-free savings accounts, savings, or speeding up into popping up your paying down the mortgage. Here it is, there is a higher interest in making lump-sum payments early on in your mortgage. The interest calculations are higher on the higher amount owing, therefore saving you way more in the beginning of your mortgage.
Another big factor in this is whether you are invested in equity in your tax-free savings account. If you were just sitting on cash in your TFSA or a low-risk fund, or let’s say a 1% GIC, then you are not going to have the same answer. I’m going to assume that your TFSA is an equity, and it is earmarked for a bit of a longer-term investment.
Seeing cash, you know, the GIC is that guaranteed income at the end of a term, they pay you and then maybe it’s just sitting in a high-interest savings account right now. That has zero growth. In fact, you’re losing with inflation. You can’t right now, but can you tell by my voice that I am not a fan of using your tax-free savings account for no growth or a mere 1%?
So let’s assume you are in bonds. That’s a lower risk considered fixed income. And I’m going to be optimistic and assume that maybe they get a 3% return. Let’s assume that the mortgage rate is 3%. I know we’re a little bit lower, but I mean, it’s going to hover around maybe that 3%. Those two cancel each other out.
Let me be conservative and say that an equity portfolio in your TFSA will get you maybe 6%. I know it can get higher, but let’s just say over time, the average is going to be 6%. I’m not going to bore you with the math calculations because you get the idea that a return on your portfolio has a better benefit than paying extra on your mortgage.
The key is how long you have the mortgage for. The best scenario in your goal should be to be mortgage-free by retirement. So wherever you are on that timeline, find out the best thing for you. If your mortgage term aligns with retirement, meaning it will be paid off by then. And you know, you’re being realistic. You’re not saying, “oh yeah, by 70”, but maybe, you know, that you want to be done working around maybe 65, that’s pushing it. But if it matches that timeline with your regular mortgage schedule, I suggest you put your extra savings into the TFSA.
Now, if you find extra cash after using your TSFA, let’s say you know, you’re doing that instead of paying off the mortgage early, you’re doing your tax-free savings account. And let’s say all of a sudden you’ve landed into some money, you’ve been gifted money from family, maybe an inheritance or a bonus at work or a tax refund.
I’ve got a couple of pros and cons to using it for the mortgage, so here they are. So the first one, the first pro, the first benefit to using it on the mortgage is that, of course, number one, you’re going to save money on interest. Each month that you make is going toward interest, and you’re going to see there’s the principal part and the interest part.
So the fewer payments you have, the less you’ll pay in interest. So that lump sum is going to push that interest down. Bonus, that could save tens of thousands of dollars every year. If you get a bonus, even you know, five or 10,000, and you’re going to just put it on to the mortgage. I mean, wow, that’s awesome. You’re going to save thousands in interest.
Another one is that biweekly payment. By turning it to biweekly, you’re going to actually be done that mortgage a lot sooner. Okay. The second benefit, which is, of course, no more monthly payments. Boy, doesn’t that feel good? By eliminating the monthly mortgage payments, you free up that cash flow that you can put towards a savings.
So, for example, you could invest it in equity for a huge bang for your buck. I do have to add here, be diligent. I have some people that pay off a mortgage and then save a little of what they were paying, but then they use the rest just to increase their lifestyle. Nope. You need to save it. You gotta be diligent.
And then the third benefit is, of course, you own the home outright. If you hit a financial rough patch, here’s the possibility that you won’t be able to maybe afford the monthly mortgage payments – or a job loss or changing jobs. It just gives you that little bit of freedom outright.
Okay. So a couple of cons, so a couple of negative things about paying off all your extra savings to the mortgage. You will earn more by investing. The average mortgage interest rates – let’s just say 3% percent. I know a little lower, but I’m going to use that around 3%. The average stock market return over ten years is about 9%.
So, if you pay your mortgage off ten years early versus investing it in the stock market for ten years, never mind growth that keeps happening with interest in there with the investing. You’ll most likely come out on top by investing in equities and, you know, for the long haul.
So the second kind of negative thing about paying off that mortgage is that you need to be very careful with the prepayment penalties. A lot of people don’t know this, is that you’re only allowed to prepay on a traditional mortgage, a certain amount each year, and there is a penalty if you just paid out all of a sudden.
And so, you want to make sure that you check with the lender and find out what that penalty is. And sometimes, it’s around 15% of the total purchase price every year that you can put down, and there’s some different things. But you’ve got to really check the fine print.
How does paying off your mortgage early fit into your retirement? So again, you got to sit down with your planner and look at the pros and cons of it for your individual situation. And it’s going to be a different answer for everyone.
If you want to stay in the house during retirement, paying it off now, so you don’t have to in retirement is the right move. You want it. You do not want a mortgage in retirement. And so, that’s actually going to guide your answer to this today. But if you’re, let’s say you’re ten years away from retirement, maybe fifteen or ten years away and haven’t yet, investing will be a better use of the money than paying off the mortgage early.
Another, the last thing to think about is, do you have other debts to pay off? The general rule of thumb is that you should focus on paying off higher interest rate debt before. The mortgage is probably the lowest interest rate that you have.
So, you know, think credit cards, think loans. You want to make sure that your excess cash is going to those and not in this emotional need to pay off the mortgage. We have to be smart about this.
There’s no clear right or wrong answer, but whether or not, you know what, whatever you’re considering, find an expert, find a professional. Get them to quantify and qualify the math answer for you because sometimes our emotion to pay off that mortgage is it also depends on your situation and your goals, and so you do have to know those answers.
That’s it for today. Send me more questions, and I love answering them at [email protected] That’s it. Talk soon.