Is it better to switch to accelerated mortgage payments or invest the extra cash?

[cwordman]

Running some numbers on accelerated mortgage payments and it seems to be a better option than non-accelerated but not better than investing in the market. Hoping someone can tell me what am I missing...Here's the math:

Year 2 etc are similar but with higher dollar value for P and I but still same % of total

Meanwhile if I were to invest $1948 (the difference in yearly acc vs non-acc payments) each year at 7% interest rate (compounded annually) - after five years it's total value is $11,202.44. This is greater than the $8,549 principal I would pay down in principal and the extra $382 I would pay in interest by not doing accelerated payments. At the end of five years, I could put $9740 (1948*5) + $1462 total interest earned towards the principal and start over again (or just keep the capital and keep adding and pay lump sum towards the end).

My original thought was that if an index fund can give me an average of 7% return, that's still a 1% better yield than being put towards mortgage (3% for interest I wouldn't pay down and 3% for the principal I would pay down)...But I am almost convinced I am running the wrong numbers or am missing something (other than the standard market returns are not guaranteed). Thoughts??

EDIT: Seems like the formatting is off for the table so here are the numbers:

Year 1

NonAcc Total - 23,374 Interest - 9,462.54 Principal - 13,911.46 %I - 40% %P - 60%

Acc Total - 25,321.92 Interest - 9,441.85 Principal - 15,880.07 %I - 37% %P - 63%

Diff btw

Acc-NonAcc - 1,947.92 Interest - -20.69 Principal - 1,968.61 %I - -3% %P - 3%

Year 5

NonAcc Total - 97,991 Interest - 37,577.08 Principal - 60,413.92 %I - 38% %P - 62%

Acc Total - 106,157.28 Interest - 37,194.33 Principal - 68,962.95 %I - 35% %P - 65%

Diff btw

Acc-NonAcc - 8,166.28 Interest - -382.75 Principal - 8,549.03 %I - -3% %P - 3%

 

[ssharon]

@cwordman

1. Tax matters. If the returns are taxed and the costs (mortgage interest) isn’t that closed the spread
2. Future rates matters. You need to compare your returns to the prices over the holding period. If you have a 5 year holding period, look at how long your rate is cheap and when you have to renew
3. Risk matters. If rates are up and your investments are down putting you underwater, are you screwed?

 

[cwordman]

@ssharon Agreed. I realized as I was responding to another comment that the interest rate increase would already affect my numbers; but also very true about how taxes affect the spread. Nice to have these criteria for assessing ROI. Thanks for the input!!

 

[ssharon]

@cwordman It’s a somewhat simpler paradigm, but my view is that once you are out of debt other than your house, max out your TFSA, then your RRSP, then pay off your house, then it could be interesting to borrow against your house to invest. If you borrow to buy securities it’s tax deductible, which improves the tax element and it means you are stable enough to take on more risk.

 

[cwordman]

@ssharon That's the plan atm. Although I hope one day I can go the Smith route once I learn enough about investing and taxation and have enough experience and discipline to see it through...#someday

 

[ssharon]

@cwordman I get the appeal of the smith maneuver, but for my personal risk tolerance, adding additional leverage when you already have a highly leveraged real estate asset, is unnecessarily aggressive. If your house is paid for, you have more flexibility in your budget to ride out rate hikes which correspond to dips in stock prices. If you have a mortgage and have to cover higher carrying costs it could blow people out (they have to sell) which is too much risk. If you have a paid for house and maxed out registered accounts, you have a higher risk budget.

 

[cwordman]

@ssharon Agreed. The appeal for Smith would only be if I could confidently find consistent cashflow like through dividends. My personal risk appetite isn't quite as large so I tend to plan for worst case scenario... Definitely see myself sticking to the less aggressive route of accelerated bi-weekly and maxing out registered accounts before considering something like that. It's tough with finance stuff because you learn none of this in school and so your only way to learn this is through secondary sources and/or when you're out in the playing field...

 

[ssharon]

@cwordman I work in finance. It’s like every other profession, you learn through experience. I don’t do personal finance, but I’ve seen companies blow up with too much leverage and the same principles apply, don’t take risk you don’t have to, or can afford too

 

[cwordman]

@ssharon This oddly makes me feel better haha!

 

[acecomando]

@cwordman 5 years is a rather short time frame when it comes to investing. So it's not reasonable to expect a 7% average over that time period, certainly not on a risk free rate.

But I also can't follow your math.

 

[cwordman]

@acecomando True, especially given how volatile things have been. Probably need a long term approach if going this route. I know the format is off but which part of the math didn't make sense for you?

 

[acecomando]

@cwordman I couldn't follow the format or know for sure what your mortgage interest rate is.

 

[cwordman]

@acecomando Yeah sorry about the formatting - I tried editing it in different ways but just wasn't working for some reason. In terms of mortgage interest rate, that's a good point. These numbers are actually older - at the time it was probably 2-3% IIRC but it's gone up now. I am on adjustable so these are higher than what I started with but lower than what I pay right now. The increases is what has me revisiting acc vs non-acc... But as I am typing this response I am realizing the 3% interest difference between acc. vs non is probably even higher now given that my payment is increasing but the increase is going towards interest, not principal. I knew something wasn't adding up. Thank you!

 

[anonymousbl]

@cwordman I mostly invest in my TFSA and keep my mortgage payment biweekly the same. Every year I take out $5000 in my tfsa and pay it towards my mortgage.

 

[cwordman]

@anonymousbl Yeah this seems like a good plan - make some interest while you're at it.

 

[anonymousbl]

@cwordman Exactly!

 

[stevebrodie]

@cwordman in theory returns on investing always beats out mortgage interest rate, but you might get downyears like last year so who knows.

At the end of the day with the amount you mentioned I don't think it matters that much which choice you make.

 

[cwordman]

@stevebrodie True. I guess I was also thinking about the compounding time it would take away (accelerated can bring it down to 22ish years) but max 4 years less on a 25 year mortgage doesn't seem like a good enough deal for missing out on 22 years of compound interest (for starters)...But who knows what can happen in 22 years especially after the last couple of years lol. Thanks for the input!!

 

[cosmostar]

@cwordman There are compounding ramifications on both sides so you can take that out of your decision.

You need to consider 2 things
1- guaranteed rate with paying off mortgage vs. higher potential rate if invested (with risk and tax considerations).

2- liquidity. Dumping your cash into your mortgage makes you less liquid where if you hold investments they can be a lot easier to liquidate if you need to

 

[cwordman]

@cosmostar Aaah tax! yes - that's definitely the other thing to account for. You make excellent points. Definitely helps to break it down like that. Thank you!!