Repay HBP or pay down mortgage?

by Mike Holman

This post is a continuation of Monday’s post which concluded that making an extra rrsp contribution is better than making an extra HBP repayment. Today’s issue is whether it’s better to make an extra HBP repayment or pay down the mortgage.

This one is not as clear cut as the rrsp vs HBP issue. If you put money into the rrsp then you could potentially make a better rate of return compared to the interest on your mortgage, on the other hand, paying down the mortgage gives the guaranteed return of your interest rate.

I would say that for a typical example of someone who owes a lot more on their mortgage than they do on their HBP, the deciding factor is interest rate risk. This is something which I’ve talked about previously and basically it refers to the risk involved if interest rates go up. One great feature of the HBP is that there is no interest rate risk because there is no interest paid. Regardless of what the prime rate is, or mortgage rates are, the amount you owe on the HBP is constant. Your mortgage however, has no such benefit since the interest charged will go up or down with the mortgage rates.

If you have extra money and you make an extra HBP repayment, then your interest rate risk will not change. If you instead make an extra payment to your mortgage, then your interest rate risk will decrease.

Bottom line then is that you should consider making extra mortgage payments and rrsp contributions before paying extra HBP payments. In my case I plan to completely pay off my mortgage and max out my rrsp and only then will I consider making extra payments to the HBP.

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{ 5 comments… read them below or add one }

1 TheFinancialBlogger

In the long run, I am sure that your investment will beat the 5% rate your a paying on your mortgage. Not only that but the money that you put back in your RRSP will benefit from compounding interest. There is no such things on a debt. I think that most people will try to pay off their mortgage ASAP simply because they do not sleep well at night thinking they owe such amount of money.

However, I do not think that people should be in a hurry to pay off their mortgage. It will always be a low interest debt. Therefore, there is always something else to do with your money that will be me profitable than paying off a 5% debt.

Cheers,
FB.

2 FourPillars

Thanks for the comment FB – I can’t argue with your assumptions since I can’t predict the future.

One point though is that with mortgages – the “long run” doesn’t neccessarily apply. The closer you are to paying off the mortgage, then the less confidence you can have that equities will outperform the mortgage rate.

Also – I believe interest does compound on debt so compounding works the exact same way as it does on savings.

Mike

3 moneygardener

The impact of coumpounding interest on debt is lessened with each dollar of principle that you pay back. Similar to the way that compounding works for you with each dollar that you invest. I agree with FB on his other points. Especially on the point he made below:

I think that most people will try to pay off their mortgage ASAP simply because they do not sleep well at night thinking they owe such amount of money

4 moneygardener

I gues that should read ‘such a large amount of money’

5 FourPillars

MG – thanks for the comment.

I’m definitely in the category of people who would sleep better if I had less mortgage to worry about. Call me crazy but that’s the way I am.

This might also be a function of the ratio of your mortgage to your gross salary. If my mortgage was equal to my gross salary then I would feel a lot better than if the ratio was 2:1 or 3:1! Age might also be a factor – If you are 45 and hoping to retire at 55 then the mortgage might be seen as a big impediment to early retirement. Someone who is younger might not worry about it so much because they have more time before retirement.

I guess different scenarios might result in different strategies.

Mike

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