By Tony Wanless
National Post
Saturday, July 19, 2003

Don't bet the house: A home without a mortgage is best retirement fund

While analysts moan about the stock market downturns of the past few years having ruined retirement dreams, millions of Canadians have been quietly laughing all the way to the bank. That is because they have been watching their real estate holdings appreciate, in some cases far faster than their retirement savings plans portfolios depreciated.

Home ownership has traditionally been the retirement savings vehicle of choice for Canadians, largely because there was no other option. Until mutual funds became popular, most Canadians were effectively shut out of the stock and bond markets. Once they were let in, there was a surge toward these investment vehicles, as a way to save for retirement.

During the market heyday, many financial planners warned that a properly diversified portfolio should include a real estate component, especially a low-cost, steadily appreciating one. If the stock market supplies the spice in a financial life, home ownership is the bread and butter -- the slow, albeit boring, accumulation of an asset that can be sold at retirement to fund a decent lifestyle.

Once the market frenzy wore off, Canadians started to hear those warnings, and heed them. Home buying has surged in recent years, and although it now appears to be levelling off, will likely stay high in the immediate future.

Along with this has come a surge in new home construction and house prices. The first quarter of 2003 saw the price of an average Canadian home rise 8.5% to $198,418, BMO Financial Group reported. This week, it was revealed home prices reached a record high in June, jumping 9.7% from a year ago to a Canadian average of $226,162. In Toronto and Vancouver, the average prices are more than $300,000. And, for the most part, this is the third straight year of rising prices.

Economists are a little confused about whether this surge will continue. However, the pessimists among them say house prices will continue to rise at least at the inflation rate, which is about 3%.

Numbers like these are putting smiles on the faces of many of the nine million Canadians who are within 10 to 15 years of retirement age who, in the wake of the stock market fall, became concerned about whether they would have enough money to retire comfortably.

However, as with any retirement investment, potential retirees should be aware that no investment trend lasts forever, and therefore limiting the costs of that investment is imperative.

There is evidence many Canadians have forgotten this truism. Several reports indicate they are using this wealth effect to refinance their homes to buy, among other things, luxury consumer goods. CIBC World Markets recently estimated Canadians have accessed about $22-billion of their home equity in the past two years.

Meanwhile, many Canadians have taken on billions more in debt to finance housing upgrades; many moving from ordinary houses to more luxurious digs. Many of these trade-up homeowners are among the generation near retirement, which means they are betting home values will continue to escalate more rapidly than costs by the time they retire.

They might be wrong in this. The BMO report also notes that the average monthly carrying cost of a home rose 17.8% in the first quarter of this year. Toronto-Oshawa, at an average cost of $1,462 a month, was second only to the traditional cost leader Vancouver, which clocked in $1,587 a month.

This is clearly "spend the retirement fund now" thinking and the obvious solution is to stop doing so, says Adrian Mastracci, a Vancouver-based fee-only financial advisor at KCM Wealth Management. A secondary solution is to pay off the home/retirement fund as rapidly as possible in order to reduce costs.

Mr. Mastracci uses a spreadsheet to show how reducing a $100,000, 6%, mortgage from a 25-year amortization to a 15-year amortization, which is near the retirement date for many people, cuts total interest costs from $91,400 to $51,200, putting about $40,000 into the retiree's pocket when the house is sold instead of piecemeal to a lender over several years.

It could also be argued mortgage paydown is the best retirement investment, even better in the long term than increasing home values. Paying a $100,000, 6% mortgage down early yields 6% (after tax) a year. The return is 8.28% to 8.4% (pre-tax) for middle income Canadians. Both yields are far better than what an investor attempting to build a solid retirement fund can get from the anemic bond market or the moribund and risky stock market.

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.