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August 30, 2019 | Plans

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Here’s the plan. Buy a house. Pay it off. Hope for the best.

That’s the strategy so many people follow. And today, with real estate at ridiculous levels, it means scores of families are trapped. Debt-servicing costs are so high there’s nothing left at the end of the month for the other stuff – an RRSP contribution. Or feeding the TFSA. Or the kid’s education fund.

Remember that scary stat from yesterday? The average Canadian in the first quarter of this year saved $20 a month. Twenty bucks. It’s nothing. Financial failure. If for some reason real estate stops appreciating, or goes into reverse, or the market tumbles and owners can’t easily sell, it’s a crisis.

Many people justify this strategy by saying (a) I got a fat mortgage and used leverage and (b) paying the loan off is the same as investing because I’m building up equity. So bug off, Garth.

Okay, relax. I understand there are valid reasons for paying down a mortgage – even aggressively, as many do (doubling up payments, making prepayments or lump sum deposits). Especially today, where home loans are often huge (a $1 million borrowing is now common in the GTA and Vancouver).

Paying it off: the Holy Grail

For example, many people have taken long amortizations – thirty years – in order to keep the monthly low. But the longer the am, the more money is sucked off as interest, so it makes some sense to pay it down. Also people nearing retirement should be trashing debt (sadly over a third still have a mortgage after they stop working).

There’s also the argument that when GICs and high-interest savings accounts are paying 2% that paying off a home loan at 3% is financially smart. Besides, this is a forced-savings plan. Facing a monthly mortgage payment makes you be disciplined, since otherwise you might spend half on women and weed and waste the rest. There are psychological benefits, too, since people have this weird nesting instinct and think they can retire and live on air, so long as they have the house paid off.

And speaking or retirement, a paid-off house also represents a pool of equity which can be tapped into as necessary through a HELOC or one of those evil reverse mortgages. Of course, it can also be sold for (hopefully) a tax-free capital gain later, and provide money to finance thirsty underwear or one of those sexy motorized wheelchairs. Yahoo.

Cruise some of the most popular financial web sites, especially those aimed at women, and you will see this pay-off-the-mortgage, trash-debt meme is at the heart of all advice. True enough, debt sucks. Especially when the economy turns south, asset values fall and unemployment goes up. A big, throbbing mortgage can squish you.

But wait. There are bigger goals.

But this is not a blanket strategy. There are also good reasons to just feed the mortgage the minimum amount and get invested in things like your TFSA.

First, you need to diversify. Seriously. Real estate is like every other asset class, prone to fluctuations. If you put all your net worth into one property at one location in one city, you’re courting risk. That could be from macroeconomic events (a recession, rising rates) to the micro (the guy next door buys an 80-foot motorhome, or the city approves a cell tower across the street). Always have a Plan B.

Second, houses don’t pay you money when you get old, droop and stop working. In fact, they cost money. You need cash flow far more than a roof when you retire, and it takes most people decades to build a pool of financial assets.

Third, the returns from portfolio investing have far outstripped real estate investing over the past decades, and across the country. Sure, some pockets have rewarded people with speculative returns on houses, but that’s not the norm. And those lucky folks only reap the windfalls if they sell. For most people a B&D portfolio churning out 6-7% returns for a few decades – especially in a tax-free account like an RRSP or TFSA – is the best guarantee of lifelong security. You can always rent a place to live. You can’t rent an income.

Fourth, with mortgage money today available in the 2% range, why pay it off? That’s close enough to the inflation rate to be essentially free cash. Take your spare funds and invest them in a nice collection of ETFs instead of making up for your lender’s mistake.

And , finally, consider how to best weather some kind of economic storm. When it hits the fan, houses become illiquid fast. Financial assets, in contrast, can be liquidated in seconds giving you instant cash. Portfolios don’t need to be insured. There are no property taxes, closing costs when you buy or fat 5% commissions when you sell. No maintenance. No grass-cutting or dog hair to scrap out of the hot tub filter.

So think about it. A one-asset strategy could be asking for trouble.

What to do, then, if you have giant real estate debt and it keeps you up at night?

How to slay a Godzilla loan

Try this: a weekly-pay mortgage instead of a monthly one. It ends up making the equivalent of one extra monthly payment per year. That trashes amortization faster and saves a bundle, with a relatively small additional expense. (Just ensure you get the right kind of weekly mortgage, where each payment is one-quarter of the monthly one.)

Or, better, ignore your cheapo-rate home loan, invest and save like a crazed, financially-rabid beaver and when the mortgage comes up for renewal use a hunk of the portfolio growth to pay down the principal. Man, that will feel good.

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August 30th, 2019

Posted In: The Greater Fool

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