In a recent post, Frugal Canadian discussed the size of the downpayment she should put down and whether she should pre-pay her mortgage. It is a question with no right or wrong answer because a number of variables (interest rates applicable till the mortgage is paid down, annual returns from a diversified portfolio during the same period, future tax rates on income, interest, dividends and capital gains, the annual churn in a portfolio etc.) are unknown at this point. That said, I’ll take a stab at providing a counter-point in this post.
We were not financially very savvy when we purchased our first home, but we did scrounge every dollar we could find for our down payment even when we had accumulated more than then 25% we needed to avoid the mortgage insurance. It seemed to be an easy decision at that time as the markets had just gone through a brutal bear market and saving 5% in interest costs seemed a good deal compared to relentless losses in the equity markets. In hindsight, it was an ideal time to put down a 25% down payment and invest the rest in the market.
We have had a few great years in which diversified portfolios earned double-digit returns and it is hard to find an asset class that lost any money. It is natural to allow recent performance to colour our decision on how to deploy our savings. However, many respected pundits are of the opinion that we are in a period of low returns from all asset classes and diversified portfolios will post returns ranging from the mid- to high-single digits. Note that the estimated returns are on average and actual annual returns will be all over the map.
In such a scenario of low asset class returns, earning a guaranteed post-tax return of 5% sounds pretty darned good and every extra dollar should go towards the down payment. The same argument holds true for pre-paying the mortgage as much as possible. Personally, the sequence for our savings is RRSP contributions, mortgage pre-payments and only then taxable portfolios.
Related: Pre-Pay Your Mortgage