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There is an excellent article written by Andrew Rickard in the April 2007, Advocis FORUM Magazine titled; What Price Freedom?
This article really got me thinking especially since the timing coincides with my son buying his first house. I was thinking about the advice my son had been given by his financial advisor regarding the use of and subsequest repayment of his RRSP'S used as a downpayment to buy his house.
Andrew Rickard, CFP, believes, as I believe that: "Eliminating DEBT isn't SEXY but it WORKS!"
Andrews article discusses the ease of getting credit, how voices on the radio taunt you to unleash or unlock the equity in your home. He says, "they make it sound like the equity in your home is a cute cuddly little animal that deserves to be released into the wild instead of the ravenous monster intent on eating its way through your bank accounts that the debt owing on your home actually is." Mr. Rickards thinks the sooner it's(the debt) killed off, the sooner they'll be free from worry."
Rickards, goes on to say that "people do not need to be encouraged to get themselves further in debt, instead they should be encouraged to start paying down debt with a vengeance."
Oh, but interest rates are so low, I hear people say, and the markets are so hot.
Why would anyone put money against a 5.5 per cent mortgage?
How about for security and a perfectly respectable, completely guaranteed, after-tax rate of return.
Here's what Rickards thinks about the interest rates and investment after tax earnings:
"Take a couple, aged 32, each earning $50,000 a year. Let's say they have a $250,000 mortgage at 5.5 per cent, with 20 years remaining. Their monthly scheduled payment is $1,710.98. If they just keep going along as they are now, they will end up paying the bank $410,634 over the next two decades. But if they were to each pay an extra $10,000 against the principal every year, they would own their own home outright by age 40 and would have saved themselves $109,937 in after tax dollars."
Rickards realizes, "that there are any number of RRSP vs. mortgage calculators that can be used to argue that the $20,000 prepayments would be better invested as registered savings, where they would generate a combined tax refund of about $6500 each year and, at a rate of eight per cent, would grow to $215,267 by the time the couple celebrated their 40th birthdays."
Rickards says though, "you cannot, however, promise the stock markets will actually return eight per cent over the next eight years nor can you say with absolute certainty that interest rates will not rise.
Neither is it possible to put a price on the flexibility and peace of mind that comes from being debt-free."
Rickards says: "Surely, an important part of financial planning is finding ways to take control of the uncontrollable. While it is possible to protect a family from loss of income due to death or ill health, the only way to insure against job loss or a change in personal circumstances is to eliminate debt. If the economy were to crater eight years from now and one of those hypothetical clients were to be laid off,
how would things play out?"
Rickards thinks: there would be a few more sleepless nights under the "put it into the RRSP" scenario. Still owing the bank $180,670.11 they'd have to deplete their savings to make the obligatory mortgage payments or they'd be foreclosed upon and out on the street." "Let's hope they chose some good investments, because they can't crawl inside of a savings plan to keep warm at night."
Rickards says, Since a home is the single biggest financial obligation that most consumers will ever assume, paying off a mortgage is like buying your way out of indentured servitude. For some clients, the pychological benefits of financial independence may outweigh all other considerations.
Of course, it would be cynical of me to suggest that some advisors avoid the subject since there are no commissions paid on debt reduction.
Andrew Rickards is a Certified Financial Planner who can be reached at www.andrewrickard.ca
