Should You Pay Off Your Mortgage Early or Invest Instead?

For many Canadians, becoming mortgage-free as quickly as possible feels like an obvious financial goal.

But I think there’s a more important question to ask first:

Once your mortgage is paid off, what percentage of that former mortgage payment will you actually invest?

I call this the 95% test.

If you pay off your mortgage early but then use most of the newly available cash flow for travel, restaurants, renovations or simply a more expensive lifestyle, you haven’t necessarily accelerated your path to financial independence. You may have simply delayed investing.

The Mortgage Victory Trap

I’ve seen this happen many times.

Someone works hard to eliminate their mortgage 10 years before retirement. Suddenly, they have hundreds or even thousands of additional dollars available every month.

It feels fantastic.

And because retirement still seems far away, that extra cash gradually gets absorbed into their lifestyle.

They travel more. They spend more freely. They become accustomed to living on a higher level of disposable income.

Then retirement arrives — and the paycheque disappears.

The problem wasn’t paying off the mortgage. The problem was becoming accustomed to a lifestyle that their retirement savings may not be able to support.

That’s what I call the mortgage victory trap.

Your Bigger Goal Is Financial Independence

For most people, the larger challenge is building a portfolio capable of supporting the lifestyle they want in retirement.

Someone hoping to spend roughly $75,000 to $100,000 per year in today’s dollars could require a substantial retirement portfolio, depending on their pensions, taxes, investment returns, retirement age and other circumstances.

That is why I generally believe the focus during your working years should be on becoming a confident, disciplined investor — rather than simply eliminating debt as quickly as possible.

Historically, diversified long-term investments have had the potential to earn higher returns than typical mortgage borrowing costs, although investment returns are never guaranteed and the right strategy depends on your individual circumstances.

For some people, aggressively paying down a mortgage is absolutely appropriate. Debt tolerance, interest rates, retirement timing, cash flow and personal risk tolerance all matter.

But paying off your mortgage purely because investing feels uncomfortable can be expensive if it means missing years of potential compound growth.

Consider Timing the Mortgage With Retirement

My general preference is to structure your finances so that the mortgage is paid off around the time you retire — perhaps a year beforehand — rather than a decade earlier.

During those working years, continue making your regular mortgage payments while directing available savings toward building your investment portfolio.

Then, as retirement approaches, two things happen at roughly the same time:

Your employment income stops.

And your mortgage payment disappears.

You haven’t spent a decade getting accustomed to extra disposable income that will suddenly vanish in retirement, and you’ve continued investing throughout your highest-earning years.

The goal isn’t simply to own a mortgage-free house.

The goal is to reach retirement with a paid-off home, a strong investment portfolio and the financial freedom to maintain the lifestyle you worked so hard to build.

Ed