Paying off your mortgage may HURT your net worth

[DonCampbell]

Paying off your mortgage could be bad for your net worth



In a society where financial planning education and free financial resources are as readily available as fast food, it is unfortunate to know 0that most people actually do not understand how to use their cashflow and capital effectively. When determining many people`s top financial objectives, a large number of people select building their net worth and paying off their mortgage at the top of their list. While at face value these seem to be rational choices, what I will show you is not only why these goals may directly contradict one another, but also how being mortgage free could very well be a detriment to building your net worth.



With rates of returns in the global equity (stock) markets all over the map and many people facing lower than planned retirement savings, RRSP contributions and investments are once again hot topics. The challenge that this presents for most individuals is a clear one ` with only a finite amount of income and financial capital, how does one allocate one`s capital to reach that often elusive net worth figure that brings him or her closer to the point of retirement? Keep in mind that retirement for the purposes of financial and real estate investment planning is not necessarily where you stop working, but rather where you no longer need to work.



The RRSP/invest versus pay down mortgage debate has for a long time been the source of much controversy. While there is no definitive answer, here are some clear cut rules that will enable you to make an informed decision:



http://blog.myreinspace.com/2014/02/paying-off-your-mortgage-may-be-bad-for-your-net-worth/#sthash.kHsv7H9j.dpuf



What has your experience been?

 

[Thomas Beyer]

The core issue is that people do not differentiate between "good debt" and "bad debt". That is at the core of Robert Kiyosaki's book "Rich Dad - Poor Dad" that exploded onto the financial planning scene in the mid 90's .. now almost 20 years ago. It certainly changed my and many other people's thinking, i.e. borrow to invest is strange to most people. But of course is critical for real estate investing or even stock market/dividend investing. i.e. borrow at 3-4% and invest at 5-10% and lever your cash 3-5 times.



This would have worked very well in the stock market too, as most stocks had bottomed at ridiculous levels in mid 2009, and many have gone up 200-500%, and so it would have been wise to borrow a million at 5% to buy stocks on margin for say $2M or even $3M and turn it into $5M to $15M. Of course even I wasn't as smart or gutsy enough, but some were. Of course, it could have gone lower still, and the $1M would be worth 0 today, or - $1M, as some real estate folks did in 2007 in real estate too and ended up bankrupt.



Related posts: http://myreinspace.com/public_forums/Real_Estate_Discussion/62-26733-133015-What_is_better_cash-flow__or_higher_ROI_.html



So, to answer the issue at hand, namely should one invest in RRSPs before reducing one's mortgage ?



Indeed try to maximize your RRSP as the ROI is between 30 to 66% "on the house".



Why ?



Do
you pay income taxes ? What is your marginal tax rate ? For most
Canadians it is well over 30% and for many it is over 40% ! Therefore,
if you put money in an RRSP the government sends you a refund of
slightly over 40% if you are in the highest marginal tax bracket !





So,
if you put $25,000 in an RRSP by March 1 you get a cheque for over
$10,000 ! Thus, your net investment is only $15,000 ! You invest $15,000
and it is worth $25,000 ! A 66%+ return in a few weeks.



If you
are in a 33% tax bracket, and you put $15,000 in an RRSP by March 1 you
get a cheque for about $5,000 ! Thus, your net investment is only
$10,000 ! You invest $10,000 and it is worth $15,000 ! A 50%+ return in a
few weeks.



Wow .. free money .. "on the house" care of the
Canadian government ! No other investment gives you such a high risk
free return. NONE !





That's why it is prudent to maximize your
RRSP contributions, as you get significant free money today, and delay
the repayment of it, via taxes on taking it out of your RRSP eventually,
for years or even decades !





Once the money is in the RRSP
account, you can then decide how to invest it. Of course, we believe
that a real hard asset, outside the stock market, such as a high demand
and recession proof apartment building, is one of the options you should
consider !



For most Canadians, investing in or
participating in real estate can be done inside their RRSP, however
there are some restrictions. Either way, inside or outside an RRSP ,
investing in the right real estate can deliver excellent long-term results
` if invested wisely !





Three broad options exist to participate in real estate within your RRSP !



Option 1: Mortgages or Mortgage Investment Corporations (MICs).



Option 2: Publicly traded stocks that invest in real estate or REITs.



Option 3: Private firms that invest in real estate (private REITs, development firms, REIT like LPs, ..)





Those 3 options are explained in more depth elsewhere.





Of
course, always, always consider return OF capital before you consider
return ON your capital when evaluating any investment option !



Make some money .. on the (Canadian) house !



Example: you have an extra $15,000 to invest. Should you buy down the mortgage and save 3% a year, or should you buy an RRSP that maybe makes 4% a year ?



Usually, assuming a 40% tax bracket, $15,000 net means you can write a cheque for $25,000 into your RRSP and get $10,000 back a few weeks later. Net $15,000 invested. The $25,000 compounded, say at 4% for 30 years is a lot higher than the $15,000 compounded at 3%. yes, you willpay taxes on teh withdrawals in 30 years, but the RRSP statement will make you feel much richer - because you actually are !