Personal Finance

Paying down the mortgage faster or not (Tax question)

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  • Nov 7th, 2018 6:07 pm
[OP]
Member
Jan 29, 2010
279 posts
76 upvotes

Paying down the mortgage faster or not (Tax question)

Hi - I was wondering for a primary residence where I rent out the basement, I understand that I can claim tax deductions, the largest of which is probably the mortgage interest expense.

Given I rent my basement out for say $1500 and my 25 years mortgage is $700k, does paying down my mortgage faster basically reduces my mortgage expense deductions in the future because I can only claim the mortgage expense deductions based on the normal payment rate, and anything extra I pay off is basically non-deductible (given the concept that I voluntarily paid off the mortgage faster despite not having to). If that's true, is the amount I won't be able to deduct actually a material amount? I'm trying to grasp how large this interest expense deduction would be given being at a high tax bracket and if it makes more sense to pay off the mortgage faster or just invest that money elsewhere. I'm generally someone who don't want to do too much work on investments so would prefer just paying off the mortgage to decrease future mortgage interest expense payments. Thanks!
5 replies
Newbie
Aug 15, 2018
20 posts
17 upvotes
Only the interest portion of your mortgage is tax deductible (while the principal part is not). When you pay down your mortgage you are only paying the principal portion and therefore these payments are not tax deductible. That being said, when you decrease your mortgage amount your interest payments will also reduce (slightly) so you will have a smaller interest portion to use as tax deduction.

The way I see it is, if you will invest that money somewhere else where you will receive better return than the interest offered by your mortgage (3% or whatever) than your money is better invested there. If its just sitting in your bank account collecting dust than definitely worth investing in your own house, regardless of the slight reduction in tax deduction.
Jr. Member
Feb 9, 2018
125 posts
79 upvotes
jillaryit wrote:
Nov 6th, 2018 1:59 pm
Hi - I was wondering for a primary residence where I rent out the basement, I understand that I can claim tax deductions, the largest of which is probably the mortgage interest expense.

Given I rent my basement out for say $1500 and my 25 years mortgage is $700k, does paying down my mortgage faster basically reduces my mortgage expense deductions in the future because I can only claim the mortgage expense deductions based on the normal payment rate, and anything extra I pay off is basically non-deductible (given the concept that I voluntarily paid off the mortgage faster despite not having to). If that's true, is the amount I won't be able to deduct actually a material amount? I'm trying to grasp how large this interest expense deduction would be given being at a high tax bracket and if it makes more sense to pay off the mortgage faster or just invest that money elsewhere. I'm generally someone who don't want to do too much work on investments so would prefer just paying off the mortgage to decrease future mortgage interest expense payments. Thanks!
Normally, mortgage interest paid for primary residence is not tax deductible. However, if you rent out a portion of your principal residence, such as a room or a basement apartment, you can only claim the percentage attributed to your rental property. The CRA bases the percent on the square footage you rent out of your total home. For example, if your basement apartment is 800 square feet and the total square footage of your home is 2,000, you can claim only 40 percent of the interest and other expenses. You will also need to pay capital gains taxes on the portion of the house that is used to generate rental income when you sell.

Another situation is that, as long as there were no structural changes to the house to accommodate the rental and as long as you do not claim the capital cost allowance on the basement (i.e. not claim the expenses but simply pay taxes on $1500 rental income), entire home can still qualify for the principal residence tax exemption when you sell.
Member
Aug 17, 2006
397 posts
79 upvotes
Toronto
You'll have to do some math to figure out the answer to your question based on the information discussed above.
Ofirsc wrote:
Nov 6th, 2018 3:44 pm
The way I see it is, if you will invest that money somewhere else where you will receive better return than the interest offered by your mortgage (3% or whatever) than your money is better invested there.
This is not quite true. Savings in mortgage interest is after tax savings. Assuming the highest tax bracket and returns in the form of interest, 3% mortgage interest is equivalent to 6% investment returns.
Sr. Member
Aug 15, 2013
756 posts
380 upvotes
Guelph
tweep0 wrote:
Nov 7th, 2018 12:41 am
This is not quite true. Savings in mortgage interest is after tax savings. Assuming the highest tax bracket and returns in the form of interest, 3% mortgage interest is equivalent to 6% investment returns.
Very true, and i see a lot of times ppl tend to miss this part. Though, if the other option is tax saving product like RRSP, than it becomes more interesting. Though, if alternate investments is stocks, as it stands, the stock markets are carrying high valuations and 6%/yr may not be realized for the next 5-7 years, so paying off early right now might be a good idea. Side note, renting out the basement may trigger capital gains tax (based on certain conditions) when you sell the house, even if its in a primary residence.
Insurance and Investment Advisor
Jr. Member
Jun 7, 2010
187 posts
16 upvotes
I am in a similar conundrum (except the rental/tax implications part)....so hopefully its ok to piggyback on your thread!?

My mortgages (2) mature in 2020, when the interest rates are projected to be higher than what we have today (expected bank prime is projected to be 5.5-6%). Based on this assumption, if I were to defer paying a lump sump payment(s) and instead create a conservative/diversified portfolio with appropriate bond allocation and equities I would guess with a time horizon of 15-20 years I would achieve a RoR of 7-8%. In contrast, by paying off the mortgage by 2020, after tax the RoR could be about 5.5-6 % (i.e. mortgage rate).

RoR from paid of mortgage combined with piece of mind that a paid off mortgage will provide me, I am heavily favoring paying the 2 mortgages off in chunks by 2020. Again, its only a projection and if the economy tanks then rates could go in different direction and my thesis will be stale :)

Also, I am in my late 30's with an aggressive portfolio (100% equites) in my maxed out registered accounts + corporate investments, so the two paid of mortgage amounts will almost be a bond allocation.

Am I missing something here or my assumptions are not very sound?

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