Home is Where the Wealth Is, But Wait to Prepay Your Mortgage! (A Mortgage Broker’s Perspective)

As a mortgage broker licenced in British Columbia and Alberta, I often see clients with that burning question: what to do with extra cash? Should they use it to prepay their mortgage or invest it elsewhere? It’s a great question, and the answer often involves more than just crunching numbers. Today, let’s explore a scenario where Sarah (age 35), a client with a $400,000 mortgage at 3.75% (amortization remaining: 25 years), has an extra $20,000 burning a hole in her pocket. Should she throw it at the mortgage or explore other options?

Prepayment vs. RRSP: The Numbers Game

On the surface, prepaying $20,000 seems like a no-brainer. It reduces Sarah’s mortgage balance, saves her interest, and shortens her loan term. However, let’s remember the power of investing for the long term. Contributing her $20,000 to an RRSP could potentially provide significant future returns, especially considering the high cost of living and potential retirement needs.

Here’s a breakdown of both scenarios:

Scenario 1: Prepayment

• The mortgage principal was reduced by $20,000.
• Interest saved: Approximately $27,000[1] over the remaining 25 years (assuming early payment penalty isn’t applicable).
• The mortgage’s amortization could be shortened by 1 year and 11 months (depending on lender calculations).

Scenario 2: RRSP Contribution

• RRSP contribution earns potential investment returns of $86,438 over 30 years (assuming a 5% annual return compounded annually).
• Tax savings on contribution (based on Sarah’s marginal tax bracket): Approximately $4,000 – $7,000 (depending on her income level).
• RRSP funds grow tax-sheltered until withdrawal in retirement.

Bonus Feature

If Sarah now takes the tax savings, assuming it comes as a refund, and either applies it to the mortgage or reinvests it into her RRSP, she has created further wealth. Depending on where the rates are, I suggest balancing out this approach and applying the refund to the mortgage.

But Wait, There’s More!

The numbers paint a clear picture: investing in an RRSP holds more significant potential for wealth creation than prepaying the mortgage. However, the decision isn’t just about raw numbers. Here are some additional factors to consider:

• Sarah’s age and retirement goals: The closer Sarah is to retirement, the more beneficial prepaying the mortgage might be for immediate financial security.
• Debt tolerance: Does Sarah feel comfortable carrying the mortgage debt? If it weighs heavily on her, prepayment might offer peace of mind.
• Risk appetite: Investing involves inherent risks. If Sarah prefers guaranteed returns, prepayment might be more appealing.

The Takeaway: It’s All About You!

As your mortgage broker, I’m here to guide you through the numbers and explore all your options. Ultimately, deciding to prepay your mortgage or invest in an RRSP depends on your unique financial situation, goals, and risk tolerance. Don’t hesitate to reach out for a personalized consultation – after all, home is where the wealth is, but building it requires a carefully crafted plan!

Disclaimer: This blog is for informational purposes only and should not be considered financial advice. Please consult a qualified financial advisor for personalized guidance before making investment decisions.

The above scenario is based on an investment achieving a higher rate of return than the current mortgage interest rate.

[1] Savings may vary and dependent on the period the prepayment was made.