Why paying down your mortgage early is not always the best idea

No one likes being in debt. Unfortunately, it’s part and parcel of getting a mortgage, which will likely see you take on hundreds of thousands of dollars of debt. Conventional wisdom says you should pay down your mortgage as quickly as possible, to stop the interest adding up. But is that always the right decision?

Why paying off your mortgage is a good thing

Of course, getting your mortgage paid off is important. For every dollar you remain in debt, you’ll be paying more interest on top. As such, many Canadians try to pay their mortgages down as fast as possible, then focus on saving for retirement.

It’s a commendable goal, but if you’ve never sat down and figured out whether it’s the best move for you, you really should.

Paying off your mortgage: A case study

Let’s assume you, as a first time homebuyer in Ontario, bought a $500,000 home and put 20% down. Let’s also assume you have a fixed-rate mortgage and got the best Ontario mortgage rate as of October 2018, of 3.13% on a five-year term. Ratehub.ca’s mortgage approval calculator says your monthly mortgage payment on your $400,000 mortgage will be $1,920 a month, with a 25-year amortization.

If mortgage rates are the same when you renew your mortgage each time (we know they won’t be, but for simplicity’s sake we’ll make this assumption), you’ll end up making total payments of about $576,000 ($1,920 a month x 12 months x 25 years).

We’ll also assume you’re able to save $863 a month, all of which you put into a registered account, either an RRSP or TFSA to maximize your tax savings. Let’s say these investments see a return of 7% a year. After 25 years, you’ll end up with over $675,765 in savings.

If you focus off your mortgage instead

Now let’s assume you save a little less cash, in order to pay down your mortgage faster. You do this until the mortgage is paid off in full. Instead of taking 25 years, you choose a 20-year amortization period.

In this scenario, your payments jump up to $2,240 a month. Over 20 years, you’ll make total payments of $537,600 ($2,240 a month x 12 months x 20 years) and pay about $38,400 less in interest.

For the first 20 years, you’ll only be able to save about $543 a month. But once the mortgage is paid off, you’ll be able to save $2,783 a month. After 25 years, you’ll end up with $584,670.11 in savings, assuming an annual return on investment of 7% and assuming you don’t blow the extra money in your pocket every month.

If you pay your mortgage off even faster

Say you’re not satisfied with being debt-free in 20 years. Instead, you don’t want to have a mortgage 15 years from now. Your payments jump up to $2,783 a month and you make total payments of $500,940 ($2,783 x 12 months x 15 years).

Once you’ve finished paying off your mortgage, you invest $2,783 a month every year for the next 10 years. Assuming a 7% annual rate of return, you’ll end up with $476,036.

You may have noticed you end up with a lot less saved than what you would have had you decided to save more and pay down your mortgage at a slower rate.

If you pay off your mortgage over 15 years, your total payments will be about $38,400 less than had you paid off your mortgage over 20 years. However, taking 20 years would see you have $108,633 more invested. When you save more right from the start and pay off your mortgage over 25 years, your total payments are $75,060 less and you have $199,728 more invested.

Why paying off your mortgage faster isn’t always better

What gives? By saving and investing earlier, you can still end up with a lot more money even though you’ve put less money away. 

It’s all thanks to the power of compounding interest. In the first example, you save $863 a month for a total of $258,900 over 25 years. In the second example, you save $543 a month for 20 years and $2,783 a month for five years for a total of $297,3000. And in the third example, you save $2,783 a month for 10 years for a total of $333,960.

Because, in this example, your long term investments through your TFSA and RRSP had a higher rate of return than your mortgage, it allowed your savings to compound much faster than your debt.

For this approach to make financial sense, the key is to invest the money in a higher-risk investment, typically in a registered account, over a long period of time. For example, if you invest in a GIC with an interest rate lower than the rate on your mortgage, paying down your mortgage early will be the better option.

The bottom line

While it may make sense to pay off your mortgage early, it’s actually not always a good idea. However, it’s never a good idea to base your financial decisions on a single blog post. There are plenty of reasons you might want to pay your mortgage off faster, such as building up your home equity or reducing the risk of interest rate fluctuations.

Before you make changes to your mortgage repayment schedule, you should speak to a financial professional, like a financial advisor. If you’re considering getting a new mortgage or refinancing, be sure to speak to a mortgage broker first – consultations are free, so there’s no risk.

Also read:

• The Real Impact of this Year’s Stress Test
• What Will a Mortgage Cost in These Major Markets?
• Comparing Fixed vs. Variable Rates

This article was original written by Craig Sebastiano in October 2019, and updated by Tim Bennett in May 2020