Alright, so it is everyone’s favorite time of year, Tax Season! Now, if you’re like me, you enjoy paying taxes as much as you enjoy finding an empty toilet paper roll in a public washroom. They’re both revolting. But in my effort to symbolically “spare a square,” I’m going to share some insight into how making prepayments on your mortgage are related to income tax.
Keep in mind, I’m a Mortgage professional & not a tax expert, but there are some very basic truisms I’d like to share:
Unlike the States, mortgage interest in Canada is not tax-deductible. The monthly payments you make are with your after-tax income — what I mean is, the payments are with money you’ve earned & already paid tax on. This makes it even more important to make prepayments on your mortgage early, as you will not only save dramatically on you long-term interest costs, but you’ll save from having to apply future after-tax dollars to your mortgage payments.
If you have a mortgage interest rate of 5%, for every $1000 of principle you reduce your debt by, you will save $50 in after tax cash each year. Looking at it this way, in an income tax bracket of, say, 40%, you need to earn $83.33 to pay the interest for every $1000 of outstanding principle so there is a huge benefit to reducing this balance.
Any prepayments — whether it’s lump-sum, doubling up payments, increasing payments, anything above your required monthly commitment — are going directly to reducing your outstanding balance. You wont’t have to pay interest down the road on that amount so you are saving your future, after tax dollars.
You could also think of this as your return on investment for making prepayments is 8.33% before tax & 5% after tax, which is better than most fixed return investments — bonds, GICs, etc.
So make lump-sum payments, double up payments when you can, use your RRSP-driven tax rebate to pay down your mortgage, you’ll not only save tremendous amounts of interest, but you’ll save from having to apply future after-tax dollars to your mortgage.
For more information on mortgage tax strategies, or learn how you should be using your prepayment privileges, contact me, I’m Ryan @ City Wide Financial.