No matter the business cycle or the trends, there are some things that never change when it comes to saving, building and managing money. Long-time Financial Post columnist Jonathan Chevreau presents the fourth instalment of the seven eternal truths of personal finance.
I’ve always said a paid-for home is the foundation of financial independence. You have to live somewhere and you can’t live in an RRSP. Most of us have a simple choice: either become a homeowner or rent from someone who is a homeowner.
You may rationalize when you’re young that you don’t want to be tied down to a mortgage. But consider that when you’re renting, you are still paying a mortgage: your landlord’s!
The problem with being a perpetual tenant is that the rent will never stop and your landlord will likely hike the rent in line with inflation. When you own your own home, the total outlay may exceed your rent in the first few years but eventually, as you pay down principal, more and more of your mortgage payments will be used to pay down still more principal, and less interest relative to principal.
Tie this in with taking advantage of the annual prepayment privileges – generally 10 to 15 per cent of initial principal – and there will come a day when your mortgage is fully paid off. On that fine day, you’ll no longer be paying interest or principal and the home will be owned free and clear. For the rest of your days, you’ll be able to live rent-free!
Let’s say that took 10 years to accomplish. Compare it to the 10 years, if you continued to rent. In year 11, you’d still be renting and likely shelling out a good deal more per month than when you first signed your lease. And unlike the mortgage, there would be no prospect of those rent payments ever ceasing. But the homeowner who paid off the mortgage after 10 years will forever more be living essentially rent-free, although of course there will still be property taxes, utility bills and perhaps maintenance fees if you own a condo.
I don’t know about you, but I’d far rather enter retirement or semi-retirement with no mortgage, or any other debt for that matter. Not having to come up with the monthly rent means your monthly “nut” is that much lower. You won’t have to earn as much and so will pay less income tax.
But there are also several other benefits to having a paid-off home.
First, a principal residence is a major form of tax shelter, right up there with owning your own business. That’s because Ottawa does not tax any capital gains on your primary home. If you bought for $400,000 and years later sold for $800,000, you’d have a tax-free capital gain of $400,000 that could be added to your retirement nest egg.
Second, if you have a good chunk of equity in your home, it can be used as collateral for an emergency source of cash. You could have a Home Equity Line of Credit (HELOC) that could be used (though I advise against it) to renovate the home, put on an addition or go on a major vacation. Similarly, retirees with no heirs who find themselves house-rich but cash-poor could always resort to a reverse mortgage to convert some of the home’s equity to a tax-free source of cash.
Again, I wouldn’t recommend this for most people and certainly not if your children or other heirs view such an act as potentially cutting into their inheritance. However, in certain situations this may be an option for those who really want to stay put and have few if any alternative sources of retirement income.
A third possibility, which is really a variation of tapping your home’s equity, is downsizing at some point. A typical retirement fantasy is to sell the suburban monster home and swap it for a downtown condo AND a cottage on a lake somewhere. Assuming the condo and cottage are each roughly half the price of the big home being sold, you’d essentially be swapping one home for two. Because of the capital gains exemption on the principal residence there would be no tax consequences, although normal real estate brokerage commissions and land transfer taxes would have to be considered. Alternatively, you could sell the big-city home for a similarly large home in the country, perhaps getting “twice the house for half the money” and adding the difference to your retirement kitty.