There’s no shortage of advisors suggesting that clients look to the struggling markets for bargains, but not everyone has the cash to buy extra stocks. One way to shore up some dollars is by getting your client to stop aggressively paying down his mortgage, and use the funds on equities instead.
With mortgage rates as low as 5%, some advisors have given thought to using a client’s additional money on the market — where there’s potential for a greater return — rather than putting a cash surplus toward the home.
“Paying off a mortgage is always an opportunity cost,” says Ted Rechtshaffen, president and CEO of TriDelta Financial Partners. “You have to ask, ‘Could I be doing more with that money somewhere else than by putting it into the mortgage?’ ”
Rechtshaffen says it’s up to the advisor to determine where best to use a client’s money. If the client has money in a GIC that’s returning 3% pre-tax, while a mortgage rate is 5.5% after tax, you’ll want to suggest paying down the mortgage. Seems easy enough, but Rechtshaffen says “it’s usually a bit more complicated than that.”
The Toronto-based planner explains that a client should think of investing and interest rates much like a business does. He says that banks often charge businesses high interest rates for loans, but that doesn’t deter companies from asking a financial institution for money. “That’s because if the bank pays 7% interest, the owner knows they can make 25% on that in the business. So they just do the math. If I can do better with this money than the interest rate, then it makes sense.”
With that in mind, he says investing, instead of paying down a mortgage more aggressively, can be a good thing. “If I can borrow at 4% and I can make 10% on my money, why would I want to take that cash and use less of it?” he asks, adding that many Canadians have an irrational fear of debt.
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“The bottom line is that it’s silly to be aggressively paying off low-interest mortgages unless your only alternative is GICs or money markets.”
Robert Abboud, a CFP and president of Orleans, Ontario-based Wealth Strategies, takes a different view. He says that whatever savings clients have after they put money in an RRSP should go toward paying their mortgage.
“It’s a much better use of money, even if rates are as low as 5%,” he says. “It’s a wise thing to have no debt when we can.”
He agrees that it could make sense to invest rather than reduce a mortgage — especially when you can deduct interest if you’re investing outside of an RRSP — but it’s not the responsible thing to do. A mortgage, he explains, is a guaranteed 5% or 6% rate of return.
According to Laurie Campbell, executive director of Credit Canada, a real problem can occur when people use their mortgage money to make risky investment decisions. “We see a lot of problems in this country from people who believe they can keep tapping into home equity to pay for the frills in life,” she says. “The reality is, people are not making money in other investment vehicles. They’re taking money and financing a life they can’t continue to finance.
“When people are retiring with mortgages or are house poor because they’re tapping into the little equity they have, the consequences can be quite severe,” she adds.
Campbell points out that many people think house prices will just increase, so why reduce the mortgage when you can just sell and pay everything off? “That’s not going to happen in this environment today,” she explains. “Nor should a client follow the idea that a house is a retirement plan, because many people stay in their homes after they retire. So cashing in is unlikely.”
Advisors will have different opinions on whether or not to pay down a mortgage as quickly as possible, but most will agree that contributing to an RRSP can be the best use of extra money.
In Ontario, residents get back 46% of their RRSP contribution and that doesn’t include growth in the actual investment. Clearly, that beats a 5.5% return from the mortgage. “In the short term, if you’re earning decent income, it usually makes sense to put money into the RRSP rather than the mortgage,” says Rechtshaffen.
“The first priority is doing a financial plan, and retirement planning would be pretty high up there,” adds Abboud. “If you hit your annual contribution mark and cover the kids’ education, then it’s a decision of what do I do with the extra money. If you still have a mortgage, it’s almost a no-brainer.”
Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com
(08/18/08)