Why paying off mortgage not always best

It amounts to financial heresy to some conservative investors, but paying down your mortgage early just might not be the best plan.

The message of debt being out of control is directed at us continually. If it’s not the finance minister telling us to stay out of debt trouble, it’s some Bank of Canada official.

There is something to this message. The percentage of household debt to disposable income dropped a tad last quarter but it’s still at about 164 per cent — close to an all-time high.

It’s not hard to see why. Interest rates continue to hover near record lows. The prime rate at most banks, which variable-rate mortgages are tied to, is at three per cent, but ratesupermarket.ca says it’s more like 2.35 per cent with discounting.

Lock in for five years and you still get 2.94 per cent for the term.

Pay that mortgage off ? Why would you bother, especially if that money could be invested elsewhere at a higher rate?

Mortgage broker Calum Ross says there is an opportunity to invest in today’s market using the money you would otherwise earmark for your mortgage. “If you don’t have a mortgage today and you are in the top tax bracket, you don’t understand the basic rules of personal finance.”

You’ll need a little tolerance for risk to adopt his strategy, but he says you might need that in order to avoid “flipping burgers” in your old age because you don’t have enough money for retirement.

For starters, you need to have some spare cash on hand. The key to his investment strategy is having some extra cash flow. You have to make a clear distinction between your taxdeductible investments and your non-tax deductible, like the mortgage on your principal residence.

“If you’re borrowing for the purpose of investing, you can write off the interest,” says Ross, adding the key is not co-mingling your debt.

One thing you could do to create cash flow — and this involves actually paying down your mortgage — is sell some non-registered investments and use the cash to pay down your mortgage. You then borrow the same money back but as an investment loan.

“It’s called a debt swap. You’re taking non-tax deductible debt and making it tax deductible,” says Ross.

Ross has a simple formula for making sure the investment makes sense. Subtract your marginal tax percentage from one and multiply by the interest rate to borrow.

Say you borrow at five per cent but have a marginal tax rate of 40 per cent, the return you would need would be three per cent.

There are also contributions you might want to make to a Registered Education Savings Plan before paying off your mortgage. The government offers a grant of 20 per cent for every dollar put into an RESP per child, up to $500 annually in grant money to a maximum of $7,400 lifetime.