Section 3: Life’s Sexy Curveballs
Life has a way of handing us unexpected challenges. Often times, our mortgage and finances take a back seat. Here are some situations you might have to deal with. In each section, we included ideas on how to manage them in regards to your mortgage.
Ajoe came to me with this question. Luckily, I had been asking myself the same question ever since my son was born.
The Government of Canada matches your contribution to an RESP by 20%. Over 18 years, after paying $42.5k into an RESP, the government grant would be maxed at $8.5k. But if you took the $2.5k each year and paid that toward your mortgage, would you be better off?
There is a threshold where this concept makes sense. The answer is ‘Sometimes’.
Download the calculator www.cashproperty.ca/tools and watch the video at www.cashproperty.ca/books to see what you should consider when trying to answer this question. Keep in mind, the age of your kids, interest rates, and risk tolerance levels all play apart in what you should do. Make sure you watch the whole video on this topic. Keep in mind, this video does not account for time value of money.
If you’re heading into a separation or divorce, you’ll likely be assessing your financial situation, as most likely there will be a decrease in income. Along with legal fees, child support, alimony and spousal support will make it more difficult to become mortgage-free in 10 years.
Often times, the property will be put on the market to sell, if neither party can buy the other out, the house will be sold and the proceeds of the sale will be split. Often times a divorce may require you to downsize.
Many of my clients who are going through a separation or divorce will attempt to keep the matrimonial home. However, this would require them to qualify for the mortgage on their own. If you’re able to qualify for a mortgage on your own, with just one income, this would be a good time to extend the amortization as long as you can so you can better manage your monthly principal and interest payments. If you have extra funds each month, you can take advantage of the GLAD.
However, if you’re unable to qualify for the mortgage and are forced to sell, you can use the proceeds from your sale as a down payment for a new home. In this case you should get the longest amortization possible, in order to keep your monthly payments low.
During this time of separation or divorce, you might ask yourself the question ‘Is it better to rent or to buy?’ This, of course depends on several factors, like the area that you are in, is the housing market completely crazy and way overpriced, do you have enough down payment, etc. Watch our video at www.cashproperty.ca/books/project-100-10-10/ to get more information as to why renting might be a better option for you.
If you find yourself in the unfortunate situation of becoming unemployed, don’t panic. If you’ve followed our earlier advice and gotten a secured line of credit, then you can use the line of credit if you find yourself short on savings, while at the same time, curbing your spending as much as possible.
Should you find yourself without employment for a prolonged period, then you might want to look at switching your mortgage frequency payment from accelerated bi-weekly or accelerated weekly to bi- weekly or weekly. In addition, you might want to contact your bank to find out what the minimum mortgage payment is that you can make without any penalties or incurring additional fees.
This is different from the forgiveness or skip-a-payment option some lenders offer. We do not recommend you do this forgiveness program or skip-a-payment program. In essence, if you skip a payment, that payment amount will be added to your mortgage plus interest from the month that you skip until the end of your term so you’d pay interest on top of interest.
One very common question is this: “Should I put my extra money into my RRSP or TFSA instead of making an extra payment toward my mortgage?” Your answer may be valid for one year and change the following year.
There are two schools of thought. One strategy involves taking the full 25 or 30 years amortization to pay off your mortgage, and putting extra money you have into an RRSP or stocks. With rates of return compounding higher than what you’d save in mortgage interest, this method allows you to diversify your portfolio and potentially grow your net worth.
Another strategy involves paying off your mortgage in order to become mortgage-free. Once you’ve achieved this, you could use the amount you once paid monthly to put you’re your investment portfolio. The difference between these strategies is that you won’t be diversified until you become mortgage-free.
Why choose one strategy over the other? It depends on which direction you think interest rates will go. Keep in mind the power of compounding interest. If you were to take the extra funds and put them into other investments to diversify, you’ll need to ensure the other investments are compounding at a higher rate than what your mortgage interest payments would be. When the mortgage interest rates are fairly low, as they are now, (the lowest they have been in years), then it might be better to contribute the extra funds into an RRSP, or other investment - just as long as you are making more than the mortgage interest rate. Although you will be getting a tax credit for any RRSP contributions made (within your unused limits), paying your mortgage down faster may make more sense.
While working as an engineer, rather than paying into my RRSP, I used my extra cash to pay off my mortgage using GLAD. As a result of focusing on paying off my mortgage, I was able to become mortgage-free within 10 years. From one property alone, I was able to save $55k dollars in interest. If I were to make the equivalent contribution to my RRSP each year for a period of 10 years, I would have received a tax credit of $45k. Even if I assume a compound rate of return of 8%, focusing on my mortgage puts me ahead by $5k. (And this doesn’t even account for the use of Mr. Equity to fund my next real estate deal.
Of course, these numbers might not reflect your situation. Keep in mind that there are many factors that made it worthwhile for me to pay off my mortgage rather than contributing to my RRSP.
The only way to know what is right for you is to run some numbers. Keep in mind, the results will change depending on multiple factors so it doesn’t make sense for us to provide any examples here. So sit with a financial advisor, mortgage agent or us to run your specific numbers.
Remember Ajoe, our new condo owner. He will be using his $25k first-time homebuyers’ RRSP deduction limit as part of his down payment. In, Ajoe’s case, he should pay back the RRSP amount each year until it is paid back in full or he will be penalized in his annual taxes. (see this website for more information: https://www.canada.ca/en/revenue- agency/services/tax/individuals/topics/rrsps-related- plans/what-home-buyers-plan/repay-funds-withdrawn- rrsp-s-under-home-buyers-plan.html)
Note: See if you can find the error on the www.canada.ca website regarding payback amounts over 15 years.