About 10 days ago, the new Governor of the Reserve Bank, Stephen Poloz, announced that interest rates will remain unchanged....Big Surprise!
This got me thinking about low interest rates and paying off your mortgage.
Over the last few years, home mortgage rates have been astonishingly low. Because of the low rates on home mortgages, many financial gurus now suggest that people hold off on paying back their mortgage. Rather than making extra payments. They suggest you can get a better return by investing elsewhere.
On the surface, that’s a great argument. Not necessarily, and here’s why.
For starters, there isn’t an investment available right now that locks you in at better than 4% guaranteed. To get a return better than that, you’re going to be investing in real estate or something else that injects risk into the equation.
If you put money into the mortgage, it’s going to give you a locked-in-stone annual return equal to your interest rate as long as you still hold that mortgage. If you make an extra $1,000 payment right now, you’re getting a 4% (or whatever your interest rate is) guaranteed return for the lifetime of that mortgage. That money actually appears at the end of the mortgage in the form of having it paid off earlier.
That’s a good conservative investment.
Still, purely as an investment, I view paying off a low-interest mortgage early as simply a very conservative option.
The reason I still advocate for it is for another reason entirely: Having your home loan paid off does wonders for your cash flow.
Some might argue that it makes sense to invest your money instead of making extra payments on that mortgage. If you don’t have enough on hand to pay off your mortgage all at once, this makes reasonable sense, as it provides a very liquid emergency fund for you. However, you’re still left with two choices – investing in something with little risk that doesn’t return as much as an extra mortgage payment (like a savings account) or investing in something with substantial risk that should return more over time but may return much less in the short term (like stocks).
There’s also the human factor. If you have a lot of money sitting in the bank, it becomes much easier to talk yourself into spending it if it’s just sitting there. You can tell yourself it’s an emergency fund, but as the balance grows, so does the temptation.
Because of all of these factors, I still consider it a solid idea for most people to make extra payments on their mortgages, even when the interest rate on the mortage is low. This assumes, of course, that you have an emergency fund already in place (to handle most of life’s disasters), that you don’t have any other debts, and that you’re also contributing to your retirement savings at a total rate of at least 10% of your income. If you’re not taking care of those things, make them a priority.
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