Cash sitting in the bank -- invest it or pay down the mortgage?

[tvp2003]

Okay, we've got some extra cash sitting in the bank account, and with a healthy tax return and an upcoming raise, we need to put it to use. We've already maxed out our RRSP's and have no debt except our nice big mortgage -- should I use the money to pay that down first, or try to invest it in some medium risk investments (will likely want to have access in 4-5 years when our mortgage becomes due, so nothing too volatile)?

I was originally planning on the investment route, but right now I'm leaning towards the mortgage. We're in the first year of a 5 year term (25 years total) so I figure any extra payments today will mean big interest savings down the road. Our interest rate is about 5.10%, which isn't a massive return but at least it's tax free.

Any thoughts/suggestions (other than spending the cash on hookers and blow?)

[tvp2003]

Originally Posted by fotze

Do you think you can invest it and earn greater than 5.1% over the life of the mortgage?

The thing is, I suck at investing, so it would have to be in the form of mutual funds, etc. I would like to get educated and look at other forms of investing (i.e. real estate, etc.), but for now I'm just looking at the basics. Plus, I'm not sure I like the idea of locking it into an investment for 25 years...

Plus, if my investment income gets taxed, wouldn't I need to earn like 6.5-7.0 percent?

[Nufy]

Originally Posted by tvp2003

Okay, we've got some extra cash sitting in the bank account, and with a healthy tax return and an upcoming raise, we need to put it to use. We've already maxed out our RRSP's and have no debt except our nice big mortgage -- should I use the money to pay that down first, or try to invest it in some medium risk investments (will likely want to have access in 4-5 years when our mortgage becomes due, so nothing too volatile)?

I was originally planning on the investment route, but right now I'm leaning towards the mortgage. We're in the first year of a 5 year term (25 years total) so I figure any extra payments today will mean big interest savings down the road. Our interest rate is about 5.10%, which isn't a massive return but at least it's tax free.

Any thoughts/suggestions (other than spending the cash on hookers and blow?)

You can max out my RRSP's if you are interested .......

[Cowboy89]

Originally Posted by tvp2003

The thing is, I suck at investing, so it would have to be in the form of mutual funds, etc. I would like to get educated and look at other forms of investing (i.e. real estate, etc.), but for now I'm just looking at the basics. Plus, I'm not sure I like the idea of locking it into an investment for 25 years...

Plus, if my investment income gets taxed, wouldn't I need to earn like 6.5-7.0 percent?

1) It depends on your appitite for risk. It's less risky to plough money into servicing your mortgage because there's less variables to deal with. However you're probably leaving money on the table as a 5.1 percent after tax annual return over a 25 year period should be able to be beat by a competant portfolio manager.

2) You're right, in Canada your return on the stock market would have to be compared to your mortgage rate on an after-tax basis

3) If you 'suck' at investing get someone else to do it for you. A Financial Advisor can do this work for you with your situation and tolerance for risk in mind. Since they can actively manage your portfolio there's no need to lock in funds for 25 years. There even is a few CP FA's who'd probably love to offer their expertise.

[V]

Pay down the mortgage, and then use the equity to invest.

[tvp2003]

I'll preface this by saying that I can see myself moving in 5 years, which is why I'm looking at that as a financial signpost.

If interest rates go up when my mortgage becomes due (or even 10-15 years down the road), wouldn't my return be higher than the 5.1%? Or even worse, if I invest in an aggressive, longer term portfolio (i.e. with a 25 year window in mind) but the market is down when my mortgage is up for renewal or for some other reason I need that money?

[tvp2003]

Originally Posted by V

Pay down the mortgage, and then use the equity to invest.

Do you mean a HELOC? We put down a 10% down payment on our first home in May 2007, which means:

a) I don't think I'm eligible -- I think you need 25% equity
b) I'm paying tons of interest

[V]

If you decide to invest without paying down the mortgage first you will have to pay the same amount of interest, just none of it will be tax deductible. Pay the mortgage first, and then use the equity to invest and the interest on your borrowed money is deductible.

[jamesteterenko]

If I read this right, you want to have access to the money in 4-5 years in order to put the money into your mortgage.

If you just put it into your mortgage immediately, you are guaranteed a tax-free return of 5.1%. I doubt that you will be able to find another guaranteed after tax return anywhere near that.

Yes, you may be able to get a higher return with other investments. But in a five year time frame, many investments will have a lower return and possibly even a loss. Is it really worth the risk if you are going to put it into your mortgage in five years anyway?

[V]

Yikes, if my financial guy can't make 5.1% per year for five years, he's soooo fired. That's just brutal.

[ken0042]

I say pay down the mortgage. But for me the sooner I'm done with that the sooner I can do other things; like vacation property.

Let's say your mortgage is $300K, and you currently have $3K to put onto the mortgage. Right now your mortgage would be around $1750, so $3K is less than 2 payments. But that $3K takes at least 6 months off your mortgage.

If you are maxed out on RRSPs it sounds like you are in good shape for retirement. Why not try to get the house paid off sooner. The sooner that's done the sooner you can retire.

[tvp2003]

Originally Posted by jamesteterenko

If I read this right, you want to have access to the money in 4-5 years in order to put the money into your mortgage.

If you just put it into your mortgage immediately, you are guaranteed a tax-free return of 5.1%. I doubt that you will be able to find another guaranteed after tax return anywhere near that.

Yes, you may be able to get a higher return with other investments. But in a five year time frame, many investments will have a lower return and possibly even a loss. Is it really worth the risk if you are going to put it into your mortgage in five years anyway?

Essentially, yes. I guess the risk I'm trying to avoid is having interest rates go up and having my mortgage payments increase substantially to the point where I'm in trouble. We extended ourselves pretty far (it was our first home), although I'm fortunate to have a good job that pays me well (hopefully I don't burn out!), so that helps mitigate against this risk.

Maybe this is too shortsighted or is a bad strategy altogether, but the way I see it, in 5 years when my mortgage is up for renewal, I'd like to make a significant lump sum payment (if I haven't done so already). Something in the $30-50K range above our monthly payments, if not more (we have a $280K mortgage). This results in:

1) Reduction in principle, which means smaller mortgage payments, which means greater cash flow from month to month.

2) Reduction in principle, which means more money from future payments will go towards principle versus interest.

I guess the thought of a 25 year mortgage doesn't appeal to me psychologically -- I'd love to be able to pay that down sooner and avoid all of that extra interest.

[tvp2003]

Originally Posted by V

Yikes, if my financial guy can't make 5.1% per year for five years, he's soooo fired. That's just brutal.

I was told that a moderately aggressive portfolio (which was recommended for a 5 year window) makes about 6-7%... which is obviously better than 5.1%, but the latter is essentially guaranteed and tax free (important now that I'm in a high tax bracket - yay!).

P.S. Thanks to everyone for their input

[firebug]

You can either eat well or sleep well.

~firebug

[return to the red]

nm just read that you wanted to have access to that money in 4-5 years

[KTown]

Originally Posted by tvp2003

Okay, we've got some extra cash sitting in the bank account, and with a healthy tax return and an upcoming raise, we need to put it to use. We've already maxed out our RRSP's and have no debt except our nice big mortgage -- should I use the money to pay that down first, or try to invest it in some medium risk investments (will likely want to have access in 4-5 years when our mortgage becomes due, so nothing too volatile)?

I was originally planning on the investment route, but right now I'm leaning towards the mortgage. We're in the first year of a 5 year term (25 years total) so I figure any extra payments today will mean big interest savings down the road. Our interest rate is about 5.10%, which isn't a massive return but at least it's tax free.

Any thoughts/suggestions (other than spending the cash on hookers and blow?)

Pay your damn mortgage as fast as you can that is my advise. Sooner or later something will happen and the economy will hit a blipp!

[Slava]

I sent you a PM. The "right" answer is contingent on your situation, but in all honesty you should probably pay down the mortgage, borrow it back and invest those funds.

This will give you the tax savings over the next five years as well as the compounding to grow the invested funds. Earning more than 5.1% over a period like this is not too risky, and easily manageable.

[jamesteterenko]

This is an interesting article published in MoneySense last year that suggest paying down your mortgage may be more beneficial than contributing to your RRSP due to the guaranteed nature of the return you get from paying down your mortgage. In trying to find that article, I also found this follow-up by a different author. They do both warn about the risk that if you go this route you may be tempted to upgrade your home too soon and not end up putting money into retirement planning, but it sounds like you have that under control.

Just figured I would give you some additional reading.

[MoneyGuy]

THe OP hasn't provided enough information to properly answer the question. What is your tax rate, what is the amount of money available and particulal details of the mortgage, what are the prepayment penalties. I might be inclined to pay off the mortgage, or part of it, and then borrow it back, effectively making that debt tax deductible. When I paid off my mortgage, I went out and borrowed the money back and invested it. That was 12 years ago. I guess I'm old. Hope this helps.

[MacDougalbry]

In situations like this, I like to ask myself: "What would Warren Buffet do?"