Investing In Your Mortgage

That old saying "A penny saved is a penny earned" is directly applicable to investment in your mortgage. There is no sense in earning 5% from a GIC if you have to pay 7% on your mortgage, your net shortfall is 2%. The wiser investment would be to invest the GIC amount into your mortgage, saving 7% and avoiding the 2% shortfall.

Keep in mind that mortgage interest on your primary residence is paid with after tax dollars. Income tax is first deducted from your gross employment earnings and then mortgage interest payments are paid out of your remaining disposable income. Given that mortgage payments are paid with after tax earnings, investment into your mortgage results in substantial savings and excellent returns on investment.

Think of it this way, if the effective annual interest you pay on your mortgage every year averages 7%, you will receive an after tax annual rate of return of 7% on all money invested into this mortgage.

For each $100 of mortgage debt outstanding, you pay $7 of interest. Therefor each $100 reduction in mortgage debt will save you $7 in after tax payments every year. However, if you are paying taxes at a marginal rate of 40%, you will have to earn $11.66 of gross income to pay this $7 of interest. As such, for each $100 of mortgage prepayment you will save $11.66 in gross income every year. This example shows that the before tax rate of return is 11.66% and the after tax rate of return is 7% Compare this to the alternative rates of return a small sum, such as $100, would earn in a savings account.

Investment into your mortgage is a great way to be mortgage free earlier and save thousands of dollars in interest. The same rules apply to investment in other debts. Credit cards are also paid with after tax earnings and usually are at much higher rates than your mortgage. The first line of attack should be against all higher interest debt such as credit cards and personal loans. Next, accelerated payment of your mortgage is a high return, risk free investment.

Balance Mortgage Investment with RRSP Investment

A balanced approach is usually the best strategy in order to maximize returns. Invest into your RRSP and use the tax savings to make prepayments on your mortgage. Alternatively you can allocate fraction of your savings to regular monthly mortgage debt prepayment and the bulk of your savings to RRSP investment. While mortgage investment does not offer the tax deferal benefits that RRSPs do, they are a high and guaranteed return. Reducing mortgage debt can reduce exposure to risk and free up equity for investment in other assets with the potential for interest deductibility.

Plan your pre-payment

Ask your mortgage lender for an amortization schedule, or go to the Canada Mortgage Schedule Calculator, detailing the mortgage payments, complete with the principal and interest amounts of each payment. By pre-paying the principal amount for a future month you will avoid paying the associated interest amount. This approach is a great way to motivate your family to stick to a prepayment strategy because it makes the benefits of each prepayment apparent. The benefits are the total interest savings received over the entire remaining period of the mortgage amotization.

$100,000 @ 7%