The Impact of Prepayment vs. Investing the Money

When It Makes Sense to Invest Extra Cash Rather Than Pay Down Your Mortgage

If you come into a little extra cash — from a bonus, tax refund, or inheritance — it’s natural to wonder:

Should I pay down my mortgage faster, or invest the money instead?

Both options can be smart financial moves. But depending on your interest rate, investment returns, risk tolerance, and financial goals, one may give you a bigger long-term benefit than the other.

Let’s explore how to weigh the decision.

The Case for Paying Down Your Mortgage

For many Canadians, paying down the mortgage feels emotionally rewarding. There’s peace of mind in watching your debt shrink and knowing you’re building equity faster.

Benefits of prepaying include:

✅ Guaranteed savings — your “return” equals your mortgage interest rate

✅ Less interest paid over time

✅ Faster path to financial freedom

✅ Improved cash flow flexibility later (when payments end sooner)

Example:

If your mortgage rate is 5.5%, any lump-sum payment toward principal is like earning a risk-free, after-tax return of 5.5%. That’s hard to beat, especially if you prefer certainty.

The Case for Investing the Money

If your mortgage rate is relatively low, or if you already have an emergency fund and manageable debt, investing may generate higher long-term returns.

Why consider investing:

✅ Potential to earn more than your mortgage rate over time

✅ Diversifies your financial growth — not all equity tied up in your home

✅ Keeps liquidity — easier to access invested funds than home equity

Historically, balanced investment portfolios (60% equities / 40% bonds) have averaged around 5–7% annual returns over the long term. If your mortgage is in the 4–5% range, investing could produce a higher net gain — especially inside tax-sheltered accounts like RRSPs or TFSAs.

How to Decide: Key Questions to Ask

When deciding between prepayment vs investing, consider these five key factors:

1. Your Mortgage Rate

   • Higher rates make prepayment more appealing.

   • Lower rates (especially under 4%) may tilt the math toward investing.

   
   

2. Your Risk Tolerance

   • Paying down debt is guaranteed.

   • Investing carries short-term volatility but higher potential returns long term.

   
   

3. Time Horizon

   • If you’ll need the money soon (e.g., for a move or renovation), paying down the mortgage provides certainty.

   • If you’re investing for 10+ years, markets generally reward patience.

   
   

4. Tax Considerations

   • Investment returns are taxable outside registered accounts.

   • Mortgage interest on your principal residence isn’t tax deductible (unless you’re applying a Smith Manoeuvre strategy).

   
   

5. Overall Financial Picture

   • Do you have high-interest consumer debt? Pay that off first.

   • Do you have an emergency fund? If not, build one before either option.

A Simple Rule of Thumb

If your after-tax investment return is expected to be higher than your mortgage rate, investing can make sense.

If not — or if you value guaranteed progress — prepaying your mortgage is the safer bet.

Think of it as a risk-return trade-off:

• Paying down = guaranteed savings

• Investing = potential growth with some uncertainty

A Balanced Strategy Often Works Best

You don’t have to choose one or the other! Many homeowners split the difference — for example:

• Put half your bonus toward a lump-sum prepayment

• Invest the other half into your RRSP or TFSA

This way, you’re reducing debt while still building your long-term wealth and taking advantage of tax benefits.

The Bottom Line

There’s no universal “right answer” to the prepay vs invest debate — it depends on your mortgage rate, goals, and comfort with risk.

In today’s higher-rate environment, prepaying can deliver strong guaranteed returns. But over the long run, investing wisely may outperform and offer greater flexibility.

A mortgage professional can help you run the numbers and align your strategy with your broader financial goals.