A former colleague stumbled upon this blog recently and sent an email asking for some guidance on his financial situation. David (name has been changed) works in the public sector in Alberta and is a married father of three young children. Here’s what he wrote:
I am one of those folks who abhors debt of any kind – not just consumer debt, but also mortgage, car – doesn’t matter.
My wife and I purchased our first home back in 2010. We paid $348,000 for it. We had what we thought was a 10 percent down payment at the time, but did not consider closing costs, etc., so that down payment turned out to be a bit less.
Related: How much house can you afford?
Since that time, I’ve been working very hard to melt that away as quickly as possible. Each year, I increase the biweekly payment amount. In addition, I regularly put extra monies toward the mortgage, where possible.
We are doing well, having paid $86,000 toward the principal since July, 2010. The issue, though, is that of savings. Rather than sock extra money away in savings, I find myself putting nearly everything (save RESP contributions) into the mortgage.
Of note, I do contribute to the Local Authorities Pension Plan (LAPP), so the pension savings are there. I have RRSP’s built up in other jobs, too, so I don’t feel as though I’m compromising there.
Is this a sound approach, in your view? I’ve been doing this for the past number of years (as we were building up a down payment before taking on the house), so I’m used to it.
Related: Should I pay off my mortgage early or invest?
My issue, of course, is that if something happened, we don’t have that much in savings.
It’s clear that David wants some reassurance that his mortgage-slaying approach is the right one. He emailed the right person because his financial situation and money fears are eerily similar to my own.
Here was my response to David:
Hi David, I can definitely empathize with your situation, as we recently bought a home that came with a $300,000 mortgage and I’d love to pay it off sooner than later. However, I try to take a balanced approach when it comes to saving, investing and paying off debt.
Consider your goals and your risk tolerance. If you hate debt and just want to get rid of it, your plan makes perfect sense. To alleviate your fear around not having any other savings, consider scaling back your mortgage prepayments a bit and divert some cash into a high interest savings account. Once your mortgage is fully paid then you can start to ramp up your retirement savings and keep more cash on hand.
Something else to consider: The pension plan is great if you stay in your job long enough to reap the benefits, but if you change jobs often then the plan won’t be worth as much to you long term. That’s why it’s important to diversify your savings through your RRSP and TFSA in addition to your pension plan.
Related: Will a pension plan handcuff you to your job?
The reason I take a balanced approach is that, like you, I don’t want all of our net worth tied up in a house and a pension. They’re not liquid investments that can easily be sold off should you need the money.
We have $2,500 a month left over after all the bills are paid. From that extra cash flow, we put an extra $1,100 a month on the mortgage, $300 a month goes into a high interest savings account (for short term goals, and a bit of an emergency fund), $200 a month goes into RESPs, and $900 a month goes into RRSPs. Like you, I have a pension, but I have unused RRSP contribution room from other jobs. Once I’ve used up my available RRSP contribution room, I’ll divert $600 a month into our TFSAs.
Your tax free savings account is your friend, for both short-and-long term savings goals. I regret not saving more in my own TFSA, but the reality is there is only so much to go around, so I prioritized the mortgage and RRSP first.
Also, I have a variable rate mortgage at 2.2 percent. One could argue that long term investing will yield more than the cost of borrowing at that rate, but there are no guarantees that will happen. Paying off the debt is a prudent strategy.
Final thoughts
David currently puts $3,000 per month towards his mortgage (monthly payment is $1,500) and, if he continues at this pace, will have a fully paid off home by September, 2020 (just over 10 years after buying the house).
Related: How to pay off your home faster
However, if David decides to ease up on the mortgage payments and instead directs $500 per month into a high interest savings account, or tax free savings account, he’ll only delay mortgage freedom day by 20 months (April, 2022) and he’ll have $100,000 in cash savings.
Something may come up where he needs that money, but it maybe not. If the cash isn’t needed then David still has the option to make a lump sum contribution to his mortgage at any time to help pay it off faster.
Readers: What do you think about David’s financial situation? Should he keep doing what he’s doing, or relax on the mortgage payments and find more balance?
