Mortgage Smarts: Pay Off Debt Sooner

For most Canadians, the mortgage is the single largest financial commitment they’ll ever make — yet few understand how much it truly costs them over time. While headlines focus on changing mortgage insurance rules and amortization periods, the real challenge lies in how we pay down our debt. Traditional mortgage structures are stacked in favor of lenders, not homeowners, often forcing borrowers to pay hundreds of thousands in interest before touching the principal.

This article dives into what the banks don’t tell you: smarter strategies that can reduce your interest burden, accelerate mortgage repayment, and even turn your mortgage into a tax-advantaged investment tool. Whether you’re a first-time buyer or years into your loan, it’s time to explore new approaches that prioritize your financial freedom — not just your interest rate.

The recent move to change mortgage insurance rules dominates headlines, but there are other mortgage options that deserve more attention. – By Don Bayer

The federal department of finance recently made some changes to the rules that govern insuring residential mortgages. Effective October 15, 2008, Canadian lenders will tighten their criteria, which will reduce the risk and exposure such as that faced by institutions in the US, and ultimately make it more difficult for some to get approved for a mortgage.

Having witnessed the carnage south of our border, this proactive move should be welcomed by the industry. In my opinion, however, none of the changes will have a material effect on the broader mortgage market, since most lenders were following their own set of lending principles. The reduction of the maximum amortization to 35 years from 40 years for insured mortgages may impact a few individuals, but the move away from 100% financing to 95% will have very little effect as the 5% may still be borrowed from another source, just not in the form of a mortgage.

In addition, the concept of a minimum credit score has been common practice for conventional mortgages for close to 10 years. In this regard, the government and more importantly Canada Mortgage and Housing Corporation are bringing their lending standards up to the industry benchmark, which in the long term will be reflected in lower default rates for these higher risk mortgages where the individual has very little equity in their property. Remember, these new rules apply only to insured mortgages in Canada.

Some of you may have heard of the ‘Smith Manoeuvre’ — a mortgage tax deduction strategy. It involves a significant amount of market risk, specifically around the returns required on the homeowner’s equity. With today’s volatile stock market environment, this particular strategy may cause a few sleepless nights. Once in a while I come across an investment strategy that really makes financial sense. What if there was a plan that actually worked without significantly leveraging your home or hoping for unrealistic returns on the invested funds?

Here’s an example of how you could save more than $100,000 in interest costs with your mortgage and generate significant tax savings along the way.

Banks constantly provide Canadians with poor advice on the cost of borrowing funds for their mortgage. We see this every day with almost every client. It’s like that shell game you see on street corners in New York. Everyone is watching the shells but no one pays attention to the hand. In Canada, we haggle over the interest rate or an extra 0.10% off, but we miss the big game.

Did you know that paying off a typical $250,000 mortgage over a 30-year period at 5.75% will cost $275,210 in interest alone? To take this example further, you’ll have to earn $870,000 to pay off your $250,000 mortgage. Have a look at the math:

• $250,000 (principal amount borrowed) +
• $275,210 (Total interest cost of the $250,000 mortgage) +
• $344,790 (approximate payment of income taxes on $870,000 in earnings) =
• $870,000 (earnings required to pay off $250,000 mortgage over 30 years at 5.75%)

Is it any wonder most Canadians find it a challenge to get ahead?

Canadians have been lulled by the banks into believing that the only important variable in their mortgage is the interest rate. In fact, interest rate is only one piece of the entire mortgage plan and more often than not, it’s not the most important part.

Earlier this year, Sid Negri, a certified mortgage professional and president of PDQ Financial Services Inc approached our company with a strategy that would allow clients who qualify to pay down their mortgage in a completely different manner — fast.

According to Negri, “the real demon is the way the government allows banks and lenders to amortize the interest and principal payments on a mortgage. Judging by the six-month payment schedule on the previous page, how can anyone get ahead? When looking at the previous mortgage example, Canadians should feel insulted that from a mortgage payment of $1,488, only $264 goes to principal or debt reduction. The other $1,183 goes to interest. The lender gets four times as much from your mortgage payment than you do. Now that’s wealth prohibitive.”

Negri’s plan was to increase the amount of principal repayment, thereby significantly accelerating the pay-down of the mortgage. “Since we administer the plan, our clients are forced to be disciplined throughout the duration of their mortgage.”
Picture two buckets, bucket A and B.

Bucket A is full of dirty water called your mortgage, which is paid for with after-tax income (the interest isn’t tax deductible). When this plan begins, you make your regular monthly payment of $1,488, of which $264 is principal and $1,183 is interest. Essentially, each month you pay down your non-deductible mortgage and then immediately re-borrow the funds and deposit the funds in bucket B.

Bucket B is the investment plan, which grows by the principal deposited each month. Every month you pay down the non-deductible mortgage and re-borrow the proceeds. Because the funds are used for investment purpose, with each payment, your mortgage is becoming tax deductible. The point is: you’re starting to reduce your personal tax burden to accelerate your debt reduction.

Depending on the individual’s financial picture, this plan can be accelerated to reduce the mortgage faster, which could reduce the time frame significantly. The goal is to pay off your mortgage in eight years. Quite often the client doesn’t need to commit more of their disposable income; they just need to spend the time getting their financial house in order.

No one likes to budget, but occasionally we need reminders on how to manage and prioritize our cash flow as it’s easy to get diverted with easy credit in this low interest rate environment. The message for the past seven years has been it’s okay to refinance your home and spend, or it’s ok to use your line of credit or credit cards to help support your lifestyle. Amortizing your lifestyle over 25 or 30 years is a recipe for long-term financial problems.

“Individuals need to begin thinking differently about their largest debt,” Negri says. “All of my clients pay professionals to manage their money, but very few have taken the time to properly manage their debt.”

The PDQ plan is formula-based and provides sound advice that Canadians need to know in order to prioritize and build wealth. It’s not built on leveraging your existing equity or predicated on unrealistic returns in the stock market. It’s a systematic approach to paying down your largest debt in the most cost effective manner with complete control.

It also requires discipline. Remember, it generally takes seven to 10 years for the average consumer to create equity in their home, either by market appreciation or by making regular mortgage payments. This plan gives consumers immediate access to their home’s equity, while providing both tax savings and wealth accumulation today.

Furthermore, PDQ makes the process easy for its clients by administering the total plan for them. It takes a little time to gather all the necessary information from clients, but after that “it’s pain free,” says Negri. “We only need to consult our clients once a year to ensure they use their tax refund to pay down their mortgage.”

Imagine using your tax dollars to pay off your mortgage in eight years and contribute to your own bottom line. The times indeed are changing.

Don Bayer is president of MonsterMortgage.ca, Toronto, and a regular columnist for Canadian Real Estate magazine.
Sid Negri can be reached at:
sid@pdqwealth.ca