One of the biggest dilemmas of personal finance management is the decision between Paying off your Mortgage or Investing the funds. As Mortgage payments are quite sizable, one may be tempted to put them to better use. This is a choice you have to consider very carefully.
First, let’s examine what a Mortgage really means.
The word ‘Mortgage’ has its roots in French. Its early usage dates back to Medieval Britain and roughly translates to “Death Pledge”. In application, it implies a pledge or an agreement being ended by any means. Either through both parties fulfilling their obligations (full payment) or by repudiation (foreclosure).
In modern times, a Mortgage refers to a legally binding agreement involving an offer of landed property by a lender and an arrangement for deferred payment on the part of the debtor within stipulated terms and conditions.
The Lender can be a bank or building society, the government, company, or an individual lessor. While the debtor can also be any individual, group, or corporate entity of legal capacity.
Arrangement to purchase Landed Property is not as simple as paying for your next Netflix membership or buying the latest iPhone model.
Real Estate is one of the most capital-intensive projects in human endeavors, hence the necessity for a deferred payment arrangement to enable people to acquire such property without having to raise the full cost upfront. Landed property can include, Homes, Office premises, Factories, etc.
Basically, any economic structure that man can build requires land, expensive materials, large equipment, highly skilled and unskilled labor. All of these make real Estate very expensive all over the world.
Average Cost of Properties in Canada
Before getting on a mortgage plan you should talk to an expert to examine the banks and other financial institutions that offer the best mortgage deals in Canada.
The average cost of owning property in Canada varies from city to city.
Expensive Cities: Vancouver – $900,000 CAD, Ontario – $750,000 CAD, Calgary – $400,000 CAD, Montreal – $340,000
Affordable Provinces: New Brunswick – $170,000, Prince Edward Island – $230,000, Nova Scotia – $246,000
Types of Mortgage
There are two broad types of Mortgage
Property Lease Mortgage
This type involves a building society. A Real Estate investor or a property owner passes the possession of a landed property to the debtor with an agreement that the debtor makes small periodic payments. The full ownership title will be retained by the Owner and only be passed on to the buyer/debtor after the complete payment is made.
If the buyer defaults the owner reserves full rights to repossess the property.
This is a case where a debtor/lessor enters into an agreement with a bank or any other moneylender(s) to receive a sum of money towards full or partial payment for a property. The bank/lender then retains the title of ownership of the property while the debtor takes possession and makes use of the property while making periodic payments to the bank.
The debtor will only receive full ownership title to the property when full repayment of the loan including interest charges is made.
Difference between Mortgage and Rent
A mortgage is different from rent in the sense that a Mortgage is a staggered payment arrangement with an aim for the lessor to purchase and own the property at the end.
Ideally, ownership of the asset is transferred to the lessor at the end unless they fail to make full payments. The amount paid periodically by the lessor is called Mortgage premium.
While rent is merely an arrangement by a lessor to pay a certain of money periodically for the temporary use of an asset. Transfer of ownership of the property is not intended and does not occur.
Why Mortgage is Better than Rent
Although mortgage premiums are usually significantly higher than rent in the long run and renting offers the freedom to relocate almost at will, the mortgage still has so many advantages over rent.
– Ownership: You gain full ownership at the end. Rent only entitles you to usage for a relatively short period.
– Insurance: In Mortgage the property is usually insured which protects you from unexpected losses.
– Recourse: The Lessee or property owner will have to make refunds and pay damages if they decide to cancel the mortgage contract without recourse to you.
Paying off Mortgage vs Investing
Having established what a mortgage means and how much money and effort can go into owning property. We can now understand why there is always a trade-off between making paying off a mortgage or Investing in other income yielding assets and endeavors.
What is an Investment?
Investment simply means setting money aside or procuring an asset today with the aim that it will generate income for you perpetually or at a future date.
Investments are of different types and forms. And people invest for different reasons. Some investments can be long-term, medium, or short-term in terms of the time frame of expected benefits. While in terms of the degree of yield expected compared to the resources committed, Investment can be classified as Aggressive, Conservative, or Passive.
Paying off a mortgage can cost a lot of money. It can take years of penny-pinching saving. Many people feel that the money can be put to better use if applied to other endeavors that yield income. While others believe that the prestige that comes with Home Ownership and being free from the burden of periodic premium payment can set you up for a more satisfying life.
So which is the better choice? Let’s examine the advantages and demerits of both options.
Why You Should Pay off Your Mortgage
- Stability: Obtaining full ownership of your property can guarantee some level of stability for you and your family.
- Sentimental Value: It can help secure the sentimental value of your property. A home can become worth more than all the money in the world because of the memories that have been made in it.
- Passive Income: It can yield Income if you decide to rent or lease it out
- Net-worth: it increases your net-worth and brings some level of social prestige
- Collateral Value: You can use the property as collateral if you choose to apply for loans in the future.
- Networking: Living in a stable neighborhood for a long time can do a lifetime of good in your social networking
- Foreclosure: paying down on your mortgage eliminates the risk of foreclosure. Foreclosure can happen if you come into hard times and fail to make premium payments regularly.
- Legacy: Paying off a mortgage can be a way to bequeath valuable property to your kids & loved ones.
- Lower Costs: Paying off your Mortgage quicker reduces the long-term cost of premium payments
Why you Should Delay Paying off your Mortgage?
- Expenses: Owning a property outright can bring a new burden of expenditure such as taxes and utility bills, maintenance, etc. that might have been the responsibility of the Lender.
- Depreciation: The value of the property may plunge in the long-run due to factors outside your control. e.g New town planning laws, natural disasters, etc.
- Relocation difficulties: Owning a home or office space makes it less easy to move to a different location
- Cash Crunch: It can consume a large portion of your savings and live little room for you to grow your wealth
- Slow Rate of Return: Real Estate value does appreciate, but it does so very slowly. Sometimes even slower than the inflation rate and cost of living of the city where it’s located. This could even lead to marginal annual losses.
Why you should Invest Instead of Paying off Your Mortgage
- High Rate of Returns: Investing offers a quicker pathway to grow your wealth
- Liquidity: In the case of a cash crunch, investments are much easier to convert into cash than it is to sell the property. Some properties can be on the market for years.
- Networking: Investing offers you a pathway to meeting different people across the world which can always come in handy.
- Economic activity: Investing leads to more activity in the general economy. It helps to create jobs and generate more taxes for the government
- Public good: Investment in sectors like Education, Health Care, Scientific or Tech Research can yield remarkable gains for society in the long run.
- Control: With Investments you have room to control the trend of your investments. You can pull out or divest at will etc.
What are some Disadvantages of Investing?
- Heavy Taxes: The government taxes income from all forms of Investment. In comparison, you don’t pay taxes on your property until you decide to sell.
- High Risks: In investment, there a risk of catastrophic losses i.e. The Stock market crash in 2007 – 2009.
- Negative Externalities: Almost all economic activity from Investments leads to negative effects on the planet or other people. E.g. Oil spillage, Gas Emissions from factories, Tech wastes, plastic waste, global warming, earthquakes & flooding caused by mining activities, etc.
- Liquidity: this can be a negative thing. If you are able to withdraw investments with ease, there is a risk to spend on frivolities like partying & lavish vacations.
- Corporate Fraud: This is very real. And it can lead to you losing all of your investment and have nothing concrete to show for it. A typical example of this is the Enron Scandal
- Government Policy: Policies of the government such as currency devaluation, industry restrictions, embargoes, or key raw materials or sanctions by the government can lead to significant losses on investments Currency devaluation can affect investments much more than
- It is difficult to bequeath investments to your loved ones without significant taxes and long legal hassles.
- Staying in control of an Investment can be time-consuming and mentally taxing. On the flip side having no control can mean huge losses and getting cheated.
Things to Consider when Choosing Between Paying Off Your Mortgage or Investing
The decision is largely a personal one. There is no hard and fast rule towards it. In technical terms, even paying off your Mortgage is also a form of Investment.
Before making the choice between Paying off your Mortgage and making that Investment, you have to carefully consider the following.
- Your Income/Savings vs Cost of the Property
- Your Age vs Ambitions (Legacy vs Wealth Accumulation)
Income Level vs Cost of the Property
Ideally, if your remaining mortgage payment is more than 50% of your current Income or Savings, then it is better to keep investing and keeping up with your mortgage premiums/insurance till your income increases.
The bottom line is, if you are rich, pay off your Mortgage. It’s a smart and rewarding way to lock-up some money.
Age vs Ambition
If you are Older and looking to preserve your wealth, preserve the sentimental value of memories in your home, leave a legacy for your children, kindred, or pets. You should consider paying off your Mortgage.
If you are relatively younger, with the hunger and to accumulate more wealth move up in life, you might be better off investing that money in other high-yield assets and investments.
But while doing this, keep an eye out for the murky waters of capitalism. Take note of some key features of a good investment.
What are some features of a Good Investment?
From afar, almost all Investments opportunities sound interesting or simply too good to pass up. Before making that final jump, ensure to take a step back and examine some of these features.
Every investment carries some level of risk. Investing is a game of taking calculated risks. For example, if you are delving into stock trading you should get a broker to examine the historical volatility and ensure your portfolio is well diversified.
If you are starting up a business, or considering any kind of Investment, profitability analysis alone is not sufficient. You should also carry out a comprehensive risk assessment to enable you to prepare for any twists and turns along the way.
A good investment is one that offers steady and stable profitable outcomes.
- Decent Returns
A good investment should offer a stream of income that is at least commensurate to the risks and resources that you are committing to it. You should be shrewd enough to access the risks involved within the payback period.
This is even more important because inflation a constant feature of almost every economy. A good investment should offer potential earnings that are at least sufficient to cover the inflation rates for the duration of the investment, till the payout date.
For example, if the annual Inflation rate in your country is 10%, an investment that yields 8% over the same period is profitable on paper in nominal terms, but in real terms, you have lost 2%.
If an investment is shrouded in so much secrecy the chances are, you are going to get your hands burned. Before committing your resource you should be aware of the basics of how it runs.
If you are investing in the stock of a company, you should be able to attend shareholder meetings, access the financial information of the company, etc. As a rule of thumb, you should never invest in a company that would not make its audited financials accessible to you.
Similarly, if you are investing in Gold or Bitcoin, or a Retirement Savings account, you should be able to access your account information and get news about the industry and market movements regularly through relevant public media platforms.
When it comes to Investing, Stick to what you know, or get to know what you are getting into.
- Rate of Return
If an investment is going to take 50 years before yielding its first returns, you should be concerned. Because, firstly, life is short, and if there’s anything Fail Army videos on YouTube and TikTok have taught us, it’s that a lot can happen in 50 seconds.
Life is full of risks. The odds of unfortunate incidents are even more heightened in business.
An ideal investment should yield returns in the medium-term i.e. 5-10 years. And it should include built-in options for a sell-out, cash-out, or shut-down if you decide it is the favorable option for you at any point
Some Valuable Investment Tips
- Look out for the red flags: If you are being assured of Profit with zero risks of losses, you are most likely walking right into a Ponzi scheme. If it seems too good to be true, it probably is.
- Take Initiative: Study trends and know when to divest or reinvest or completely withdraw from an investment regardless of whether your objectives have been reached or not.
- Stick to what you know, or get to know what you’re getting into. This means that you should ideally only invest in things that you have prior knowledge about. The other alternatives are to get an expert to advise you about the industry or study it yourself. Never invest blindly in what you know nothing about.
- Be patient and disciplined.
Investing is a great endeavor that should be encouraged. If done right, it will most definitely yield a better pay-off in terms of future earnings than paying off your Mortgage.
While clearing out Mortgage payments on the other hand will do a great job of helping you to preserve your wealth and avoiding risks of catastrophic losses.
The big question is, are you looking to grow your income or preserve your wealth?