A reader recently asked me:

What would have the biggest payoff, putting $5,000 annually into a savings account or using it towards your mortgage?

It’s a good question, and one I haven’t thought seriously about because I don’t have a mortgage, but I was in a math mood this weekend so I decided to work it out.

### Assumptions:

- You buy a $500,000 home (the average price in Canada) with 10% down
- You have a $5,000 surplus that you can use to either put in savings or pay towards your mortgage
- Your savings account grows tax free (TFSA)
- You earn an average rate of return of 5% on your savings because you invest in the stock market but aren’t that great at it
- You secure a mortgage interest rate of 2.39% for the first 5 years of your mortgage and 2.99% for the 5 years after that
- Your house appreciates at 3% per year, but this is irrelevant because you’re a homeowner in all three scenarios
- You don’t renovate your home or move
- You never make withdrawals from your TFSA

All that said, there are too many unknown variables over 25 years so these calculations are for entertainment purposes only and not to be taken as professional financial advice. Even I gave up trying to guess mortgage rates at year 10 and lazily left it at 2.99%.

Nevertheless, let’s indulge.

## Result: It’s better to save money than to make extra payments against your mortgage

At first I didn’t even really believe this, so I kept doing the calculations over and over, lest I end up publicly shamed on the internet for my terrible math (which will probably happen anyway). But no matter how many ways I did it, saving still came out ahead of paying down your mortgage:

I used RateHub and Mortgage Intelligence for the mortgage calculations, and my spreadsheet is available for download right here in case you want fuddle with some of the numbers yourself.

## It makes very little difference how you use $5,000 in the first 5 years of home ownership

As you can see from the table, the difference between putting $5,000 in your savings account versus on your mortgage for the first five years of home ownership is a whopping $800. You’re still ahead with saving, but barely so.

After 25 years, the homeowner who opted to put $5,000 extra into a their TFSA instead of towards their mortgage, comes out $80,000 dollars richer than the person who thought it was worthwhile to put the cash towards his mortgage just to become debt-free 5 years faster:

Even though the aggressive mortgage payer opted to redirect their mortgage payments and extra money to a tax free savings account for the last 5 years, they couldn’t catch up to the investor who had already been diligently putting a smaller amount away for two decades.

So if you needed any incentive to save, that would be it. But why are the results so dramatic?

## Cash is liquid and generates income

Money in the bank (or the stock market) offers two major perks that early mortgage payments don’t: liquidity and income generation.

Liquidity is the biggest advantage to cash savings over a paid-off house. You can always withdraw $1,000 from a savings account or sell a stock to cover an unexpected expense, you can’t take a few windows out of your house to pay bills. Even if two net worth numbers were identical, I’d take a situation with a savings account and some debt over zero-savings and zero-debt. You want to be able to make choices with your money, and you can only do that if you actually have money at your disposal to spend.

This is where everyone will chime in that you can secure a home equity line of credit if you focus on paying down your mortgage. This will provide you with the ability to spend money just like cash does. But unlike cash, a HELOC is at an interest rate that works *against* your net worth instead of for it, so while you might reclaim the flexibility of savings, you won’t have the second most beneficial part of cash investments: income.

Cash generates income in the form of interest, dividends, or capital gains. Even at 1%, cash in the bank is better for your net worth than mortgage pre-payments simply because cash will earn a compounding return and mortgage pre-payments won’t. Paying your mortgage early will get you out of debt faster and save you interest, but even if you pay off your home 5 years ahead of schedule, it’s not enough time to catch up to the person who’s been letting their investments grow for 20 years. This holds true even if the mortgage interest is higher than what you can earn in your savings account, and if you want to know why, check out this post: Why You Shouldn’t Rush To Pay Off Your Mortgage.

You’ve been told this before, but it’s true: compound interest really is the most powerful force in the universe.

As a general rule of thumb, I’m always more interested in income than debts, and passive income is my favorite thing of all. Investing cash will give you an attractive passive income stream, paying down your mortgage won’t.

## Nevertheless, it depends on what you value

Complete and total debt-freedom is a goal everyone should have, but how fast you get there depends on how much it matters to you. You can and should focus on whatever is most important to YOU when it comes to reaching your financial goals and designing your life, and this includes savings and home ownership.

But really, you should not pay extra on your mortgage and just save the money instead.

I held my breath through all of this and then sighed dramatically at the end. We are paying down our mortgage aggressively because it makes me really uneasy and anxious. We are also saving aggressively, but I know there are many people that would argue we are foolish to pay 2-4x our mortgage payment each month. We do re-evaluate our strategy fairly regularly, which I think is probably the best part of our strategy. Thanks for putting so much thought into this and crunching all the numbers. More things for us to consider!

It really only works this way because mortgage interest rates are SO LOW in Canada. Even 1% higher makes the math less forgiving.

Also, the end result counts on you not spending your savings on anything else, which very very very few people have the discipline to do. If you even took as little as $10,000 out of your savings to go on vacation or something, you would reduce the payoff.

(Also assumes you don’t take a HELOC out on your house, which would also work against you…. unless you take a HELOC out in order to invest, but that makes an even murkier conclusion)

It was fun to compare the results but even I’m not wholly convinced — too many unknown variables over 25 years, particularly with regard to mortgage interest rates!

Super interesting, especially since I might be buying a place within a year and feel like my first hit of “real debt” will be a glass cage of emotion. I love seeing this broken down, because it’ll help me remember that no, the mortgage is not actually a house-on-fire emergency and that sending a healthy amount of money to top up savings is still a big priority! Thanks for doing the math on this one Bridget 🙂

hahaha mortgage is definitely not a house-on-fired debt!

Glad you enjoyed the post!

We just published a similiar article like this last week. It’s always important to note the interest rates of the mortgage and the average return on a stock market. Right now, (USA) mortgage rates are so low that you can get more bang for your buck by doing a lower down payment and putting the extra cash into an income producing investment. Great article.

Thanks! Glad you enjoyed it!

US mortgages are better to because your interest rate is fixed for the entire term of the mortgage — wish we had that here!

This is really simple to understand, but the “fear factor” surrounding DEBT makes people (myself included) make irrational choices with our money. Here’s the breakdown: if your expected investment return is greater than the interest rate on the mortgage, invest instead. Especially if it’s a tax-advantaged account, then it’s a double win(!) lowering your tax bill and paying your future self!

Amen!!

Hi Bridget,

Good one… How can I contact you in person for a suggestion ?

My email id is macwhitby@outlook.com

Thanks !

I like your approach to all this. I just did a similar analysis (for the U.S. market) comparing the economics of 30-year mortgages versus 15-year and 20-year mortgages.

As you suggest here, the longer you can hold onto mortgage debt, the better the overall result for your finances…assuming you invest in the meantime.

I will note a small difference of opinion: I wouldn’t say that cash earning 1% is sufficient to offset the interest expense of a mortgage. You’d need a slightly better rate of return, I think.

If you’d like to check out the article, it’s linked here: http://www.financialibre.com/a-15-year-mortgage-costs-409112-more-than-you-think/

Nice post!

Does it make a difference that in Canada mortgage interest is not tax deductible? Honest question – I’m just curious about the background of your difference of opinion.

One of the best ways to save as well as pay off your mortgage early (I disagree with another poster who said it’s irrational considering things like job insecurity and the amount of money that is paid in interest on a mortgage), is to be a DINK – Double Income No Kids. More money coming in from two adults means more savings and bigger lump sum mortgage payments. Fortunately your’re already a dink, Bridget.

Liquidity is such a huge point. A HELOC will almost always be available if you suddenly need cash, but that “almost” can be deadly in the rare case that you can’t access it when you need it.

It can work against you too if you don’t have a strong savings bent (it’s easier to withdraw and blow the money on stuff than it is to pull from a HELOC to do the same), but that shouldn’t be something readers here need to fear 😉

Thanks for the mention. It’s funny when people say they can sleep better at night with a paid off home. But for me it’s the opposite. I would be very concerned and have trouble sleeping if I knew I was leaving so much potential money on the table. Plus, there’s a lot of risk in having most of my wealth tied up in a single asset class, which is exactly what would happen if I focused on paying down the mortgage instead of investing and diversifying.

I think that terms like “diversifying” are loaded terms for the small investor. Ordinary people don’t have enough money to “diversify” their investments to any great extent. All you can hope for is a typical balanced portfolio and cross your fingers hoping that it performs ok since each fund/stock/sector acts as a hedge against each other. This amounts to moderate growth but no guarantees either.

Let’s say that investing provides greater returns on average than real estate. The old adage holds true – the greater the risk, the greater the rewards. Hence, real estate is a safer bet since the rewards are lower. But this can be negated by utilizing its income generating properties.

Indeed if you’re set on investing, you could always put your tenants monthly rent into your investments so that you own real estate and still benefit from the investment growth that this blog strongly advocates.

This is fascinating and something I’ve been wanting to do for a long time! Now I’ll just use your spreadsheet. Thanks 🙂 I’m U.S. so my rate is higher but definitely not as high as the long-term return for investments, but I still get bogged down by the thought of paying more in interest if I choose to take the long road of paying my mortgage. So many variables!

My husband and I are about to buy a home, and both have wanted to put at least a little extra toward the principle each month. I see the math, I downloaded the spreadsheet, but it’s definitely a mental block. Taking on that 30 years worth of debt is already overwhelming (no matter how excited I am about the house), but earning more investing is that much more important. In the US interest rates are great, though a little higher than what you proposed above, so I’ll definitely be running the numbers.

One kinda funny thing is the home equity loan you mention. I don’t understand when people default to that as a kind of “emergency fund” or cash reserve—it’s neither, and I don’t even consider it as an option with finances. Like you said, you can’t sell your windows if you all of a sudden need a new transmission!

I love this post, so much. And I’m so happy you did the math for me, because I can’t say I’ve ever been in a “math mood” in my life haha. I’ve had a mortgage for a year, and I admit that it’s caused me some anxiety that I never really planned on paying it off early. I take the approach of putting my money towards savings instead, but I struggled about whether this was the right decision, and this post and your math is putting my mind at ease! I saw your discussion on Twitter about this, and I know that for some, the psychological benefits of paying down the mortgage are worth it, but for me, the financial benefit trumps every time. Thanks for all the research and work you put into this awesome post!

I do pay extra on my mortgage, but I only pay extra after I’ve maxed out all of my retirement accounts AND saved for all short term goals, and have at least a six month emergency fund in cash. If you’re not saving 20% of your gross income for retirement, it isn’t even a question whether you should pay extra on your mortgage or invest it. You need to get yourself up to 20% of your gross income invested every year for retirement – that’s why the RRSP limit is at 18%.

So: put this $5,000 into your TFSA. If you have no more space available in your TFSA, then evaluate whether the tax deduction of the RRSP is useful. If it is, put the money into the RRSP. Only ask yourself if you should pay extra on your mortgage when you’re beyond set for retirement. You have (I assume) 30 years to pay off the mortgage, just like you do to save for retirement. Make sure you’re doing both.

Yeah but you’re ultra ninja level when it comes to wealth-building 😉

Totally agree that once your saving accounts are maxed out, it’s probably worthwhile to then focus on vanquishing any leftover debt, including mortgage, no matter how low the interest rate is. I think the only dangerous thing many people do is forgo amassing a cash cushion in the quest to be mortgage-free. Having cash savings is so so so important (as you obvs already know!)

I really like this post; however….

TL;DR – 5% > 2.99 or 2.39%

#truth

Thank you for answering my question, Bridget! I never expected something so thorough and a spreadsheet to boot. Awesome!

Happy to, Shantel! Glad the post was helpful =D

Hi again, Bridget!

On closer inspection of your spreadsheet, I too got the uneasy feeling that something just didn’t seem right. I think we can check with a major point here: so long as the interest rate of the investment is equal to the interest rate of the mortgage, both options should give the exact same result – but they don’t. In fact, when the TFSA rate is 0.00% , the investment option still comes out on top, but only after the mortgage rate is increased.

I *think* the reason is that you forgot to account for the actual amount that a person pays. After the 5 year term, the mortgage rate increase only applies to the balance of the loan. This means that once you have made additional payments, when you renegotiate the loan, the loan payments will be smaller than if you didn’t make any extra payments.

In this example, the homeowner with no extra payments would have his monthly mortgage payments increase from about $2042 to $2157 (and so would the homeowner who made 2.5K extra payments up to $2084), but the homeowner with annual 5K extra payments would actually have her monthly payments decrease to $2011. She could then take that extra money – and even the additional money that the first homeowner is paying interest on – and pay off the principal directly each month.

This is a lot more math than I anticipated, but I think that at some point in the next couple of weeks I will be in a math mood too and will fiddle around some more with your spreadsheet. You have organized it and did the bulk of the work in a way that my mind couldn’t wrap itself around. Thank you doing this – I know it must have been a tonne of work!

Like I said in the post, I didn’t do extensive calculations for it (for example, you can see that the mortgage amounts are just pasted in from the results I got from RateHub and the Mortgage Intelligence calculator instead of doing the calculations in the sheet). It was not a ton of work, it was just a spreadsheet.

I assumed $2,000/mo mortgage payments, which is lower than the actual result I got from RateHub ($2,039 for the first 5 years). Yes, the monthly mortgage payment would decrease for those pre-paying their mortgage because the balance is being reduced, but this will only be by a few hundred dollars. Nevertheless, maybe they do add this on top of the principal, and perhaps it is enough to make pre-paying your mortgage look more attractive… but only in this scenario.

And this scenario is intensely flawed.

Historically the stock market returns 10% annually, which makes the TFSA an infinitely better vehicle for investment than pre-paying your mortgage, no matter how you slice it. The only reason to pay down your mortgage is because you 1) hate any kind of debt and/or 2) don’t know how to invest in the stock market, because really the math will never work in your favor. (This is why I used 5% as my return on the TFSA with the justification that this means you know how to invest but aren’t very good at it — you can and should be able, at the very least, to keep up with the market, and that should be 8-10%)

Without knowing with certainty future stock market returns and mortgage interest rates, there’s no way of really knowing what’s the best option. However, as long as mortgage interest rates remain low and double-digit returns can be earned in the stock market, it will always be better to invest rather than pay down your mortgage.

This is a phenomenal post. Thanks Bridget for sharing this with everyone. I have ran the numbers myself as well and if I were to buy a home (still a proud renter), I would not rush to pay it off. In my personal opinion, liquidity gives you options that home-ownership does not. It is great to buy a home if you can afford (i.e. min 20%, 1%-2% value of house saved for repairs, steady income etc) but once you have one, there should be no rush to pay it off. Diversification of all assets in a portfolio is important. Great post, really enjoyed the read.

I literally have a blog post in my drafts titled “How I Could Pay My Mortgage Off in Ten Years – But I’m Not Going To”

Like you, I did the math, and boosting my savings by maxing out my (and husband’s) TFSA’s just makes so much more sense from a long-term wealth perspective. Thanks for breaking it out so clearly – I’ll certainly be linking up to this blog post.

Great post Bridget! As someone on the other side of the mortgage equation, (having paid our mortgage off) I can say math-wise you are 100% right. There is no arguing over the numbers. 5%>2.99%

You also nailed it on the last paragraph, it’s all about YOU! The difference isn’t about the money but how you feel. If you can deal with investing in the market and taking a 3-year bear market and watching that money dwindle down then investing may be alright for you.

Also if you can handle mortgage rates jumping up eventually (I’ve been thinking they would for 10 years and have been wrong so what do I know), then investing may be the right path.

If you value security and freeing up cash flow quicker then paying down the mortgage may be a better way to go. That’s the great thing about personal finance. It’s all about what you as an individual relate to and find to be most important.

Personally, I’ve never regretted paying it off, a lot can happen over the life of a mortgage (recessions, bull markets, life cycle changes) and knowing I don’t have to make that payment is great.

I love doing the math. Thank you for this. We did earlier this year and we realized that we would get a better return throwing extra money into RRSPs vs increasing our mortgage payment. That said there are 2 things I keep in mind myself when this thought comes up.

One is having a mortgage is a HUGE burden and I want to take advantage of the super low rates.

Two each person is different and each situation is different. There are too many variables to make one decision for the rest of your life and not change it.

I couldn’t agree with you more about the HELOC – it’s not the same as cash at all.

Hey, Bridget. Excellent analysis. Mrs. Groovy and I have had this discussion in relationship to student loans rather than mortgages. Our niece just recently finished grad school and has about $70K in student loan debt. Our advice to her was to invest in her company’s 401(k) up to the match rather than dispatch her student loans as quickly as possible. We didn’t do an analysis as thorough as yours, but we came to the same conclusion. Decades of compound interest is hard to beat. And 20-somethings should take advantage of it if they can.

Something I don’t see mentioned is PMI. I am currently paying PMI on my loan, and so I have been aggressively paying on that to get rid of the PMI much sooner. Once the PMI is gone I will re-evaluate my strategy.

You are wrong saying making 1% in a savings account is better than paying 3% interest on a mortgage…. You still experience the effect of compound interest when you pay off the mortgage because as you gain equity and get further into the life of the loan, there is less debt and therefore less interest charged and more equity credited with each payment.

This is not how compound interest works.

Eh… Yes it is. If you pay off part of the borrowed capital early at interest rate x% but keep paying the mortgage interest at the original rate, the effect on your net worth is the same as if you put money into a HISA at x% and let the interest compound.

Mordko and Austin are correct. Also, your earlier statement that markets provide investment returns at 10% on average is inaccurate. I suggest 5% to 7% is more realistic, although many would say that is still too optimistic. Suggest you see Michael James’ critique of this article, I think you would find it useful.