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Chantal wants to pay down debt, invest and buy a property down south but isn't sure which to prioritize.
My husband and I are struggling with the classic “do we pay down the mortgage or do we make minimum payments and put all of our extra money into investments” question. Our situation is a bit unique in that we are in our early 40s, have no consumer debt, one adult child, we owe about $200,000 on our home and have about $250,000 in investments. We earn just over $200,000 per year combined and would like to buy a second home in a warmer climate, but we aren’t sure what would be the best financial strategy to make it happen.
–Chantal
You’re not unlike many Canadians, Chantal. You have limited dollars chasing multiple priorities. Making the right choice boils down to prioritizing and projecting. If you prioritize your goals and project the likely outcomes, you can decide if the financial and lifestyle implications are in check if you make one choice over the other.
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Here’s the thing: Mortgage debt repayment is investing. Now that interest rates have spiked, the return on investment is pretty compelling too. Your return comes from interest savings from paying down the principal portion of your debt. Avoiding interest is like earning a guaranteed return.
Sometimes, people choose to invest instead of paying down debt. If you think you can earn a higher rate of return on your investments than the interest rate you’re going to pay on your debt, in theory, you’re better off. In practice, it depends. And today, the threshold for the return required to exceed the interest rate on your debt is steep.
Over the past 30 years, the five-year posted fixed mortgage rate has averaged about 6.4%. Canadian stocks have returned about 8.7% and bonds have returned about 5.5% annually on average, while U.S. stocks have returned about 9.9%.
After many years of low interest rates, borrowers are starting to reconsider their debt levels and the decision to invest or pay down debt.
If you and your husband are going to invest instead of paying down your mortgage, I’d suggest you do what you can to make your mortgage interest tax-deductible, if it isn’t already. If it’s not, you can consider using your non-registered investments to pay down mortgage debt. If you then borrow to invest, the interest is generally tax-deductible. I’m always leery to borrow to invest, but you’re really already doing it if you have debt and investments at the same time.
Of course, if the interest rate on your mortgage is a low fixed rate, you may not want to pay down your mortgage just to borrow back at a higher rate. The tax deductibility may not be worth it if your rate has more than doubled.
Given that your investments are earmarked to buy a second home in a warmer climate, I’d make the argument that you should consider investing in that second home now. If you invest in stocks and bonds with the intention of then pulling out that money to buy the home, why not consider investing in the home in the first place?
Even if you’re not in a position to use a potential vacation property as much now in your 40s as you might in your retirement, you can consider renting the property out in the interim. Otherwise, forgoing the potential rental income while the property sits largely empty may not be the best financial choice compared to either renting it out or just waiting to buy it when you can use it more. Property management companies can facilitate this for you, typically for a fee of 10-20% of rents collected, depending on their level of service.
If the property is in the U.S., you have to report rental income on a U.S. tax return. You also have to report the income on your Canadian return. Any tax paid in he U.S. is eligible for a Canadian foreign tax credit to avoid double taxation.
U.S. real estate may or may not be a better investment than stocks or bonds, Chantal. Only time will tell. But there is something to be said about an investment that you can use and enjoy like a vacation property. There are always different ways to pursue your financial goals. Weighing the potential financial and non-financial implications of your decisions will help you choose the right path for you.
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Can you comment on tax implications to buy property in the state?? Also renting the property .
what are the taxes implications for Canadian investors?
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