With interest rates at some of their all-time lows, if you are renewing your mortgage in the near future you might be saving money on your mortgage payments. Don’t think of this as free money, but instead a faster track to savings and long-term wealth growth. By re-investing this money in 1 of 2 ways, you could save yourself thousands of dollars in the long run.
My mortgage payment is going down!
I’m at the end of a 5-year fixed, 3.19% interest rate for my mortgage. On May 1, 2017 I’ll be renewing my mortgage for a new 5-year fixed term at 2.64%! My monthly mortgage payment will be going from $753.92 to $710.09. A savings of $43.83 every month!
Unexpected means I won’t miss it
$43 a month doesn’t seem like a huge amount of savings, but the beauty of it is that it’s monthly, and it’s money that I wasn’t expecting and wasn’t planning on having. And if I wasn’t planning on having this money, that means I won’t miss it if it’s gone.
A mistake many people will make with this money, is adding it into their day-to-day funds. They’ll spend it on coffees, spend it on dinners, or spend it on entertainment. Now that’s not the worst thing to do with a little extra money, but think of the long-term implications.
Option 1: Re-invest into mortgage
An easy way to re-invest this money is put this surplus back into the mortgage payments. I’ve been paying $753 every month for the past 5 years no problem, so why not top up my new cheaper mortgage payment to the same amount. Everything stays the same, but the following happens:
- I have a forced savings of $43.83 every month, or $526 yearly
- I’m getting a guaranteed 2.64% annually on this savings
*Numbers calculated using http://www.canadamortgage.com/calculators/amortization.cgi
Over the 5 years of the term, I’ll have paid off an additional $2,754 of the principle of my mortgage and be on track to pay off my mortgage 2 years earlier! All of this with my payments staying exactly the same as it’s been for the past 5 years.
Option 2: Auto-invest into TFSA/RRSP index investment savings
The other smart (but longer term) option available for this mortgage surplus is to setup an automatic payment into an investment account. Hopefully you already have a portfolio of index funds setup. Set an automatic investment transfer for the same schedule as your mortgage payments and the same amount as your surplus. Again, it will seem like nothing changes, your payments will seem to stay the same. But you will be helping grow your long-term wealth.
What this investment could look like
Investment returns will always be unpredictable. When we estimate the return of what this extra money could look like when invested, we have to remember:
- 5 years is not a long time in the investment world. You may have to ride it out longer to see returns. Be prepared for volatility and be ready to wait it out.
- You can never be sure what that investment return will look like.
In an index fund or ETF portfolio, over the long term, we could modestly estimate an annualized return of 6%. If we saw those returns in the first 5 years, here is what our additional investment could look like when we invest that $526 annually:
Almost an additional $3,000 in 5 years, for investing that small surplus every month. And if at the end of this 5-year fixed term, your mortgage goes back up and you have to discontinue adding to these savings investments, that’s OK. What you’ve already saved will continue to compound and grow.
Which route should you go?
This is really a question of whether you are into long-term savings, or shorter term savings, and your comfort with volatility. If you add your surplus directly into your mortgage payments, you are guaranteed your 2.64% annual return on that investment for the next 5 years. If you go the index fund/ETF route, it’s impossible to tell if that investment will go up or down in the short term, so you must be determined to wait out the market to see your returns.
In the end
I can’t recommend enough to hold back your emotions with the ‘free money’ you receive from a lower mortgage interest rate. It’s not always exciting or sexy, but saving a little bit every month can benefit you so much more in the long term.