• Mortgage Free? Congratulations! But Why?

    February 26, 2020
  • mortgage freeMortgage Free? Congratulations! But Why?

    So you bought a home and paid off the mortgage quickly either by receiving an inheritance, or diligently making larger payments, or putting in the time, or any combination of the above. The goal for a lot of people is to become mortgage free as soon as possible. Why? Obviously because it means that you won’t have mortgage payments anymore! Without a mortgage, your shelter costs consist of mainly property taxes, heating, utilities and insurance. Sounds great! Now you have all that extra cash flow that you can either spend or hopefully put into some kind of savings or investments.

    But does it make sense to leave all of that equity tied up in your home? Could it be put to better use?

    Let’s do a comparison:

    Client A – Mortgage Free:

    She has paid off her mortgage completely. She’s mortgage free and she’s celebrating! She used to have a $250,000 mortgage and she was paying $1200/mth towards principal and interest.

    Her plan is to take this extra $1200 per month and put it towards an investment that will generate a 10% return. She does this for a period of 5 years.

    After 5 years, client A has saved up: $91,873.48

    Client B – Keeps Her Mortgage And Invests:

    Client B takes a different approach. She leaves her $250K mortgage in tact (or refinances her previously mortgage free home). She takes the $250K and also invests it at 10% for the same 5 years. Client B cannot brag about being mortgage free but she keeps quiet. Unlike client A, she makes no contributions to the investment because she has a mortgage to pay! After 5 years, the $250K investment has grown to $402,627.50 and her mortgage has been paid down to $193,210.44. She cashes out her investment and pays off the mortgage.

    After 5 years, client B has saved up: $402,627.50 – $213,686.76 = $188,940.74

    Who’s further ahead and how???

    Client B is further ahead because she leveraged her home at 3% to invest at 10% and make the split; more than double Client A. Essentially, client B made a net 7% on a larger amount of money from day 1. Client A made 10% on a much smaller amount that took time to grow as she slowly contributed to the fund every month.

    There is a 3rd client!

    Client C – Takes Her $250K Mortgage And Buys A Rental:

    Instead of paying off her primary residence to become mortgage free, Client C takes the $250K and uses it as a down payment on a rental property. She puts $250K down on a $500K rental. That means client C now has a $250K mortgage on her primary residence and $250K mortgage on the rental. That’s a total of $500K worth of mortgages. Client C is paying $2400/mth for a 5 year period. Her $500K duplex is generating $4000/mth in rent. The renters pay the utilities but the Client C is responsible for property taxes at $5000/year.

    Over the 5 year period, Client C:

    1. Paid down the $500K of mortgages to $427,372.90.
    2. $25K in property taxes.
    3. $144K in mortgage payments on the rental.
    4. Collected $240K in rent.
    5. Sells the home for $600K.
    6. Pays off all mortgages.

    When the dust settles, Client C is left with:

    $600K (sale of home)

    +$240K (rental income)

    -$427,372.90 (remainder of mortgages)

    -$25K (property taxes)

    -$144K (mortgage payments on rental)

    = $243,627.10**

    That’s after 5 years. But let’s be realistic – Client C is not selling this property after 5 years. Imagine if Client C held onto the rental long enough, she could actually refinance it and repeat on a 2nd rental property!

    Time is money and the equity in your home is an incredibly valuable asset!

    Sean Howard is a Mortgage Broker. His office is located at 651 Fennell Avenue East in Hamilton, Ontario. If you would like to speak with Sean, he can be reached at 905-574-9200 #216. Alternatively, you can contact Sean here.

    If you would like to apply for a mortgage online, please follow this link.

    If you would like to see our Google reviews or leave one yourself, you can do so here.

    **Note: to keep it simple we did not factor in legal costs buying and selling the rental property or the realtor’s commission to sell the property.

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