Rate phobia

How close to the edge do most people skate?

Those infamous surveys from the debt-counseling folk tell us half we little beavs are $200 or less a month from going over. In other words, one missed paycheque would create financial chaos. The surveys also show four in ten people actually keep adding on debt without increasing their assets. In other words, they borrow to make debt service payments. And we know how that ends. Badly.

Well, in this vein, Jerome in balmy Edmonton has a question.

“Hi Garth, I’m in a tough spot with my mortgage renewal coming up mid-September,” he writes.

I’m coming off a fixed term at 2.61% and have about $150k to pay off, so given a solid 250k household income I’m not really going to be put too far out of place. What’s the best course of action? Take a year at a bit higher of a fixed rate in the hopes I can sign for five at a lower rate in Summer 2024? Or just sign at ~5.6% now on a five yr term and relax?

I have the option of paying about 50k off pretty easily (surplus from renovation fund that is my sweat equity) to reduce the principal at this renewal as well. For some context we just turned 40 and live a pretty modest lifestyle with a single beater car, cheap hobbies and habits etc.”

How tough a spot is J in?

Well, a mortgage of $150,000 at 2.61% carries payments of $680. Yup, cheapo. And it’s a fair bet that in his lifetime a home loan at that rate will never return. Currently a fiver fixed averages 5.6% at the major banks. Variable loans are 6.8%. (Inflation is running at 2.8% and wages have been increasing an average of 5%.)

Renewing at the five-year rate will result in a monthly of $924, and increase of $244, or eight bucks a day. And did you notice that Jerome has a household income of $250,000? And he’s stressing about this? Sheesh.

I asked what family household assets look like. The reply: “I have the option of paying about 50k off pretty easily (surplus from renovation fund that is my sweat equity) to reduce the principal at this renewal as well. For some context we just turned 40 and live a pretty modest lifestyle with a single beater car, cheap hobbies and habits etc.”

Should he burn through the fifty grand with a lump sum payment upon renewal?

That would keep the monthly at about the same level. Over five years the saving would be $14,600. If Jerome were to invest the $50,000 in his TFSA and achieved a 6% annual return (we expect more, but let’s be moderate), after sixty months he’d have $67,000. So, marginally ahead keeping the liquid assets and renewing for five years at the current rate.

But the real benefit lies ahead. By the time J is 65 in twenty years the fifty should become $165,510. If he makes an annual TFSA contribution of $6,500 (which will augment, surely) he’ll have $409,000. That would throw off about two grand a month in tax-free income for the rest of his life – which is considerably more than CPP pays.

But, but, the house-horny myopics cry. What if he just put the money into more equity and banked on real estate appreciation?

Yes, it’ll probably happen. But money in house equity is not income. It pays you nothing. In fact, mortgage-free houses cost money just to own, in property tax, maintenance or insurance. Then you must sell (minus commission) and invest the funds to realize an income stream. The risk is where the real estate market will be at the moment you must liquidate. And what if a cash-strapped, desperate government has by then reduced or eliminated the principal residence capital gains exemption?

Remember a basic blog truth: you can always rent a roof. You can never rent income.

Seven in ten Canadians do not have an adequate or guaranteed pension plan. The public pensions (including OAS) pay peanuts. Most people need to replace at least half their working incomes to live in retirement. In fact, it’s a myth that cash flow needs crash when you retire. Are you going to sit at home and brush the cat? Or use your valuable, diminishing time to actually do stuff?

Being afraid of mortgage rates is silly unless you bought far more house than you can afford. Earning a quarter million a year and have scant liquid assets is a yellow flag. You’re headed for the wall.

About the picture: “Garth: When I visited earlier this year,” writes David,  “this Mona monkey was being held captive to amuse tourists at Concord Falls on Grenada, Eastern Caribbean. Maybe it will amuse your blog dogs too.”

To be in touch or send a picture of your beast: [email protected]