By Cathie Ericson
Are you hesitating between saving for the future and paying off your mortgage? Before making a decision, answer the four questions in this article.
Not easy to know what to do with your savings, especially with all the different financial needs to consider. That’s why it’s essential to save on two fronts: in a short-term emergency fund and a long-term Registered Retirement Savings Plan (RRSP). But there are also other options, like making extra payments to pay off your mortgage. This way, you’ll save on interest and pay less later. But is this the best way to use your money?
This strategy is indeed popular. According to the 2019 Sun Life Barometer, many homeowners prioritize paying off their mortgage. But 20% of them say they are still paying it off in retirement. According to the same survey, less than one in five people make it their top financial priority to save for retirement. This may explain it, as they say. (The Barometer is a survey that gauges people’s attitudes about their health and finances.)
Prioritizing your loan repayment and neglecting other types of savings can eat into your retirement nest egg. And you may have fewer options for managing your current cash.
I was wondering which strategy to adopt? Here are four questions you should ask yourself to set your financial goals.
- How long do you have left before retirement?
The further away retirement is, the more important it might be to start putting money aside for your retirement. Your money will grow thanks to compound interest as long as you don’t touch your retirement accounts. It is interest paid on interest; wholesale free money.
Let’s say you contributed $1,000 to an RRSP, and it earns you 5% interest. That’s $50 more. (To do the math, multiply 1000 by 0.05, and you’ll get 50.)
So you have $1,050, and that amount will also earn you 5% interest. As you have understood, the longer you let the money sit in your account, the more your savings will increase.
Are you saving enough? Try this RRSP calculator to find out.
Repay your debts or save for your retirement? Here’s how to properly prepare for your future.
- How much do you still have to pay to repay your loan?
When you are almost done repaying your loan, you may want to increase your payments to get it over with. But in reality, paying more is primarily applicable at the very beginning. Indeed, given the compound interest, you then reduce the amount of interest you will pay over the entire term of the loan.
So, we have seen that compound interest makes your investments grow faster. However, they also save you money if you repay a large part of your loan’s principal* earlier. (*The principal of a mortgage loan is the actual balance of the loan, without interest.) Thus, your lender’s interest is calculated on a smaller sum.
Do you need mortgage insurance?
Three ways to pay off your mortgage quickly
Mortgage protection includes life or critical illness insurance to help cover your mortgage payments if you become seriously ill or die unexpectedly. Get an online quote today.
- Do you want to move when you retire?
Perhaps you plan to live in a smaller place or change regions in retirement. You can get some of your retirement income from selling your home if you move.
What if you don’t move? So using your surplus money to pay your loan will mean that you will have less money available.
You need to know where the money will come from that you will use each day during your retirement. You also need to know if this money will be accessible at any time or not. You may have to sell or refinance your home as your main asset depending on the case. You may also have to use money from your retirement accounts.
How much money will you need in retirement?
- Do you earn more by investing or paying off your loan sooner?
This is arguably the most critical question. Suppose you make an additional payment of $19,000 to pay off your loan. According to a report by Mortgage Professionals Canada, this is the average lump-sum payment of those who increase their prices.
With a loan at 5% interest, this additional payment represents an after-tax return of 5%. In effect, you reduce the amount you owe the bank on which you pay interest.
But can you earn more than 5% by investing? It’s possible
