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By Paul Vieira
Financial Post
November 24, 2001
QUESTION: In December, I am expecting to receive a $45,000
windfall. I can either invest that money or pay off the mortgage
on my house. I am retired and a single woman. I have a variable
rate mortgage which, at the present time, is at a rate of 4%.
My questions are: Should I pay off my mortgage and be free of the
$350 monthly payment? Or should I hold on to the mortgage and invest
the money in a mutual fund or blue-chip stocks?
I am hesitant to let the mortgage go when the rate is so low. Also,
if I do invest the money and hold on to the mortgage, how can I
do it so that the interest paid on the mortgage is eligible as a
tax deduction since I am using the money to buy a Canadian investment?
My only income comes from the Canada Pension Plan and Old Age Security,
and withdrawals from an existing registered retirement savings plan.
ANSWER: Adrian Mastracci, president of KCM Wealth
Management, a fee-only planner in Vancouver, says the reader
should consider the following, depending on her tax bracket. According
to Mr. Mastracci's calculations, if the reader is in the 25% marginal
tax rate bracket, she will earn a 5.33%
"risk-free" return if she pays off the mortgage immediately;
at the 35% tax bracket, a return of 6.15%; and in the 45% tax bracket,
a 7.27% return.
A 5.33% return, or higher, is hard to duplicate in the current
environment—even if the person is in the 25% tax rate, Mr.
Mastracci says. By comparison, a five-year guaranteed investment
certificate currently yields about 3.6% before taxes. Furthermore,
if the current mortgage is not repaid, the interest cost will remain
non-deductible when the $45,000 is invested, whereas any income
generated from the new investment would be taxable.
Hence, it makes sense to repay the current mortgage in full, free
up the monthly mortgage payment and then decide how much to invest
in a new investment with borrowed funds, Mr. Mastracci says.
However, caution should be exercised on the amount of borrowing,
because the reader is retired and over the age of 65.
As an alternative, it's perhaps more appropriate to invest the
$350 monthly savings in a dollar-cost averaging scheme, Mr. Mastracci
says. This avoids the prospect of having to repay a loan if an investment
loss is incurred.
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