Is it better to pay off your house or save for retirement?
There’s no simple answer. In fact, what you choose depends on your economic situation.
Some people have access to a short-term emergency fund. Or they’re already contributing to a registered retirement savings plan (RRSP). Their answer will be different than someone who is looking to consolidate their debt. Or someone using the debt snowball method to reduce their monthly home payments.
Wondering which strategy is best for you? Here are four questions to ask yourself before you decide.
1. How long do you have until retirement?
It’s almost always a good idea to start saving early. Why? Because the longer you save, the more your money will grow. This is thanks to compound interest. That's the interest you earn on the interest (it’s like free money).
For example, let’s say you contribute $1,000 into an RRSP and it earns 5% interest annually. This would put an extra $50 into your bank at the end of year one. In year two, the 5% interest would then accrue on $1,050 and so on into the future. (See? Free money!)
2. How much do you have left on your mortgage?
Let’s say you’re close to paying off your mortgage. You may want to bump up those payments. But the extra payments do best when you’re just starting to pay off your mortgage. That’s because you’ll be shaving down the amount of interest you pay over the life of the loan. Again, this is due to compound interest.
It compounds your savings when you pay off more of your mortgage principal* early on. (*Your mortgage principal is your actual mortgage balance, not including the loan interest.) Doing so leaves a smaller sum to accrue interest from your lender.
3. Do you want to move, stay in, or rent your house when you retire?
Let’s say you’re planning to downsize or relocate in your retirement years. That means you can fund part of your retirement income through your home sale. You can also stay in your home and earn income by renting part of it, like the basement.
But what if you want to stay in your home? Spending your excess money to pay down your mortgage will leave you with less cash on hand (i.e., liquid funds).
To figure out which scenario is best for you, create a retirement budget with a financial planner. You’ll be able determine things like where your “golden years” income will come from (pensions, part-time jobs, etc.). They can also help you determine if you can access money when you need to (e.g., pulling from RRSPs).
The goal is to get a clear idea of where your finances stand. You can then decide whether you should sell or stay in your home. Or whether refinancing or renting it out makes sense.
Need help with your budget? Talk to an advisor.
4. Could you earn more by investing than paying off your mortgage early?
This is probably the key question to consider. Let’s assume you’re applying an extra $26,500 to your mortgage. That's the average lump-sum payment made by Canadians allocating extra to their mortgage in 2020.
Let’s say you have a 5% mortgage on your home. The extra amount you’ve applied to your mortgage is equal to a 5% after-tax return on your money. That’s because you’re lowering the amount you owe the bank, on which they charge you interest.
Could you do better than 5% by investing? It’s possible. Of course, the stock market can be tumultuous. Unexpected events can lead to a temporary drop in your portfolio. Plus, you can’t predict future returns based on past performance. So it may not make much sense if you’re not comfortable with risk.
You’ll also want to consider that investments like RRSPs can carry tax benefits. For instance, any investments you have growing in a RRSP are tax deferred. This means you won’t have to pay tax on them until you withdraw funds. This can make retirement investing more attractive.
Talk to an advisor
Still not sure which option is right for you? A Sun Life advisor can help you navigate your financial needs and point you in the right direction. It’s time to act: Find an advisor.
This article is meant to provide general information only. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation.