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rob carrick

High house prices can damage your retirement.

It all starts with young couples buying homes with mega-mortgages. Realizing how incredibly much they owe, they start stressing – and using any extra cash to pay down their mortgage.

Sounds sensible, right? And it is, except for one thing. Young couples would achieve a better financial balance by investing that extra cash for retirement than using it to pay down a mortgage that will gradually disappear all on its own.

The percentage of homeowners taking steps to get their mortgage paid off sooner has been steady since 2000. But the way people are attacking their mortgages has changed in a way that highlights the heavy load of paying a mortgage and all the other costs of everyday life.

The latest mortgage market survey from the Canadian Association of Accredited Mortgage Professionals shows that 15 per cent of homeowners have been increasing the amount of their payments in recent years, down from 19 per cent in the 1990s and early 2000s. Instead, owners are increasingly paying down their mortgages with lump-sum amounts. Sixteen per cent of owners did this in recent years, a rate that has crept higher since the 1990s.

Increasing the amount of your regular payments gives you less flexibility to manage your household cash flow – that's an explanation of why lump-sum payments are becoming more popular. From the perspective of rising interest rate risk, these lump-sum payments make sense. The more you reduce your outstanding mortgage balance, the less you have to refinance at renewal. Moreover, lump-sum payments do the most good in the early years of a mortgage, when your regular payments are skewed toward interest and you barely dent the principal.

But lump-sum payments that come at the expense of retirement saving can unbalance your finances. You'll be emphasizing your house too much and giving retirement too little attention.

Just as you get the biggest benefit from mortgage prepayment in your early years of home ownership, so do your retirement savings profit from contributions made when you're young. So don't tell yourself you'll make up for neglecting your retirement savings when your mortgage is paid off.

If you contribute $5,000 to your retirement savings annually for 30 years and get an average return of 5 per cent after fees, you end up with $348,804. If you tripled your savings to $15,000 but invested for only 15 years, you'd end up with $339,862. Think you'll have scads more money to put in your retirement savings when your house is paid off? You may find that other expenses get in the way.

For example, paying off the mortgage may have left you with little or nothing to contribute to a registered education savings plan for your children's college or university education. You may want to catch up when your mortgage is paid off. There may also be a temptation to take on new debt, maybe through buying a car. Or, you may decide to move to a bigger house and thereby take on more mortgage debt.

A traditional way of looking at the quandary of paying down the mortgage or investing is to compare the interest rate on the mortgage to the return on the investment. Mortgage rates are in the 2- to 3-per-cent range these days, while net investment returns in the 5- to 6-per-cent range are achievable. If you look at those returns on an after-tax basis (mortgages are paid with after-tax money), they should still be a bit ahead of today's low mortgage rates. At rates closer to historical norms, mortgage pay-down make more sense.

If you bought a house at the April national average resale price at $409,708, your mortgage with a 5-per-cent down payment and mortgage default insurance premiums included would be $399,926. If you made monthly payments at $1,893 (assumes a 3-per-cent mortgage rate), you'd have the mortgage paid off in the standard 25 years, assuming no prepayments. If you paid $946 on an accelerated biweekly basis (26 payments per year), then you're down to 22.2 years.

That's an entirely reasonable time frame for getting a mortgage paid off in advance of retirement. Even if you buy in your mid-30s, you're clear of the mortgage before 60 without making a lump-sum payment. You don't need to rush.

Finally, let's ask a veteran financial planner how she answers the question of paying down the mortgage or investing for retirement. "I have a philosophy of doing a little bit of a lot of things," said Barbara Garbens of BL Garbens Associates Inc. "A combination of both is probably what I would recommend to a client."

Globe app users please click for table showing how home owners are trying to pay off their mortgages ahead of schedule.