While eliminating debt always feels good, it’s important to contrast that with the long-term returns that can be achieved in a diversified equity market.Getty Images
When Maya, 37, and Nikhil, 39, bought their home in Calgary ten years ago, it felt like a bit of a stretch. With solid jobs in health care and some help from family, they were able to make a 25 per cent down payment. Still, they knew it would likely take 30 years or so to pay off their mortgage.
Now, the couple is weighing an important financial decision. Nikhil recently received an inheritance from a family member, but they are wondering where those extra funds will serve them best. They already contribute regularly to RESPs for their 10-year-old son.
Should they aggressively pay down their mortgage to become debt-free sooner? Or should they invest those extra funds to grow their nest egg?
Weigh the pros and cons
“This scenario is quite common – we see it every day, especially with recent changes to interest rates,” says Ryan Klein, mortgage advisor for CIBC.
He notes that paying off debt always feels good, “because nobody wants to have a mortgage forever.” Reducing the number of mortgage payments that Maya and Nikhil need to make could enable them to allocate more money towards retirement or travel with family. That option also offers a degree of predictability the market can’t guarantee.
Mr. Klein adds that individuals with a CIBC mortgage have the option to make lump-sum payments any time without penalty, up to a certain annual limit.
“Typically, that’s 10 to 20 per cent of the original mortgage,” he says. “Having that flexibility gives our clients peace of mind.”
That lump-sum payment goes directly towards the mortgage’s principal sum, Mr. Klein says, which reduces the overall debt and the total interest paid over the life of the loan.
At the same time, Mr. Klein points out that tying up all your funds in a mortgage could leave you unprepared for an unanticipated financial emergency.
For example, Mr. Klein says homeowners who’ve recently moved or are undertaking a construction project should work with their advisor to have a plan in place to account for unexpected expenses.
“There could be an unplanned renovation on a new home because they found an issue, or the renovation could end up being more expensive than they anticipated, so sometimes it’s best to see what the first six or twelve months bring.” Other factors to consider may include inflation, risk tolerance, job security and any large expenditures on the horizon.
Start with a holistic view
Mudit Jain, senior vice-president of specialized advice at CIBC, says that decisions about how to allocate surplus cash should begin with a full review of a family’s financial picture. Taking into account both short-term priorities and long-term objectives helps ensure that larger financial decisions are aligned with what matters most.
“The next step is to compare the return on your money,” he says, which typically involves comparing the existing mortgage rate against anticipated market returns.
“While paying down a mortgage offers this guaranteed reduction in the amount of interest you’ll pay over the term of the mortgage, you have to contrast that with the often-higher long-term returns you can potentially achieve in a diversified portfolio of securities.”
Another overlooked factor is tax implications, Mr. Jain says. He explains that while after-tax earnings used to pay down debt will reduce mortgage interest expenses, those same dollars invested through a registered account may deliver immediate and long-term tax advantages.
For example, the tax-free growth offered by a TFSA can, in some cases, outweigh the benefits of accelerating mortgage paydown. The optimal approach, however, depends not only on an individual’s tax position, but also on broader financial goals, risk tolerance, life stage and the sequencing of debt repayment versus investing.
“As always, it’s important to speak with a financial advisor to fully understand the after-tax implications and determine the strategy that best fits your overall plan,” he adds.
While paying down a mortgage provides a guaranteed reduction in interest costs over the life of the loan, Mr. Jain emphasizes that it should not be viewed in isolation. Higher-cost debt, such as credit cards, personal loans or lines of credit, may warrant priority before directing additional funds toward mortgage prepayments.
Mr. Jain notes that timing also plays an important role. Making prepayments ahead of a renewal in a higher-rate environment can help reduce future payment shock, while committing to aggressive paydowns when rates may decline can limit flexibility later on.
Insurance and protection planning need to be considered too, he adds.
“Adequate life and disability coverage can increase a household’s comfort with carrying debt, helping protect against income disruption and unexpected life events, and reducing the pressure to aggressively eliminate a mortgage before other financial priorities are addressed.”
Model different financial planning scenarios
Mr. Jain says it’s worth remembering that the decision doesn’t have to be “either-or.” Maya and Nikhil may choose to allocate some of their savings to mortgage prepayments while investing the rest.
“You can work with a professional CIBC financial advisor to model different financial planning scenarios,” he says. “For example, tools such as CIBC GoalPlanner allow advisors to show how various choices, whether investing, paying down debt or balancing both, may affect a client’s overall plan over time.”
When it comes to decisions that shape borrowing, saving, investing and long-term financial security, Mr. Jain says it’s important to take the same approach you would if you had a complex medical or accounting question, and work with a professional who can provide personalized advice.
“These are nuanced decisions that benefit from expert input,” he says. “By working together, CIBC financial advisors and mortgage advisors help align borrowing, investing and protection strategies, ensuring advice is coordinated, goal-driven, tailored and we can help you really understand what the best option is for you.”
Are you feeling torn between paying down debt and investing for growth? Book a meeting with a CIBC advisor today.
Advertising feature produced by Globe Content Studio with CIBC. The Globe’s editorial department was not involved.