this post was submitted on 24 Jan 2024
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We had to sell a piece of dream property this year because rates made payments go up so much that we could barely do minimum payments. We had planned to build on it eventually. Inflation and interest rates made it impossible. Now the dream is a memory. We just hope we can hold on to our current house.
I can afford my house even at 5% because I intentionally bought WAY under what I was approved for. I knew the lower interest rates wouldn't hold... and there was no way I was willing to buy into a multi-million dollar home at 1%. Rates go up and down over time. I bought based on the assumption that a renewal would be in the 6-8% range. At 5% I can afford it just fine... question is, do I want to?
A LOT of people I know bought right at the max they were approved for, and at 1-ish percent interest. Renewals are coming up within the next 12 months or so, and they are already panicking. That $2M home is going to suddenly become VERY expensive... well beyond their ability to pay for it.
I plan to sell this year... and take that equity, whatever we get, and set ourselves up elsewhere outside of Canada.
+1 for being cognizant of the fact that interest rates wouldn't stay low forever.
I bought my place near the limit of what I could afford, but always mentally prepared for the idea that my monthly payments could go up by 50%.
The weird irony is that since interest rates crossed over the 5% mark, I was thinking that I needed to start making lump sum payments to knock down the total interest I'd be paying -- but throwing the money into my investments has paid back far, far better... One of my broad-market ETFs is up 25%. A tech ETF is up nearly 50%. I'm considering the idea that it might make sense for me to retire with a mortgage, because the markets are going up enough to cover the monthly payment, and then some.
From a purely expected return perspective it only makes sense to pay back debts vs investing if the credit spread in the debt is larger than the investment's risk premium.
For secured debt (like a mortgage) held by someone with reasonable credit the equity risk premium is most likely larger than the credit spread.
The analysis becomes more complicated when you take into account an uncertain income stream to use against the debt. Paying off your mortgage is like buying insurance against the tail event that you lose your house because you can't make your mortgage payments.
Insurance is generally a negative expected return activity. But the value is in reshaping the outcome distribution. Your average outcome is lower but you've flattened out the tail.
I'll readily admit that my situation isn't common. I almost have enough money in my TFSA alone to wipe out my mortgage. But I've easily gained several years worth of interest expense. And while I don't expect that it'll stay that way forever, a drop of more than 10 or 20% is... unlikely.
In fact, you've got me thinking that when my mortgage comes up for renewal in a couple years, I may opt to cash out some savings to wipe out the mortgage, and take another look at early retirement.