In Money

Should you clear your debts first (including your mortgage) or save for retirement?

This is one of those old, on-going debates of whether or not you should clear all your debts first or save for retirement.

Personally I’d do the former.

I’d clear my debts first (every debt, including mortgages), and THEN save for retirement. I know you’d lose out on compounding interest in the time it takes to clear your debts, but here are my reasons for leaning towards debt repayment first:

1. YOU CAN LOSE YOUR INCOME AT ANY TIME

This is a big one.

You can lose your job, get hurt and not be able to work, or for any number of reasons that would prevent you from making an income.

What doesn’t change? Your expenses.

You STILL have to make that mortgage or debt payment, and you don’t have a choice.

Would you rather be in a position to have to make a smaller minimum payment on your current debt that impacts your finances NOW or would you rather feel good about having X amount in retirement savings?

2. RETIREMENT SAVINGS ARE GENERALLY LOCKED IN

I dunno about you but once I stick money in my Registered Retirement Savings Plan (RRSP), I can’t take it out.

I can borrow from it and use it for a down payment or for continuing education, and so on, but I still have to pay it ALL back within a time frame.


It’s not like I can take out the money and clear my debt in times of financial distress and feel total, utter relief.

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3. YOU ARE STILL SAVING, BUT ON THE INTEREST PAYMENTS INSTEAD

Now people might feel weird because they’re not saving any money, but you kind of are.

You’re saving on having to pay extra in interest because you’re forcing the principal (main) balance down to as low as possible, which makes your interest payments lower.

5% interest payments on $100,000 (which is $5000) is very different from 5% on $10,000 (which is $500).

4. YOUR RETURNS ON INVESTMENT ARE NOT GUARANTEED

Even if you save all your money into index funds, it is for the LONG run that you will make an average of 5% – 7% as a return, but it doesn’t necessarily mean that in THIS YEAR that you are paying back your debt, you will make those returns.

For me, the surer bet is your debt repayment in terms of return on investment.

5. SAVING FOR AN EMERGENCY IS NOT THE SAME THING

Note that I didn’t say you should forgo all saving.

I still think having a little extra cash as a buffer for your bills is always a good idea.

The best example I can think of for this is if you don’t keep a cash buffer in your account, you might have a bill that automatically comes out and charges you more than it should have (!!), so it ends up setting off a nasty chain reaction of missed bill payments or insufficient funds (NSF) fees that culminate in you screaming into the phone trying to get back your money due to their screwup.

THE ONLY EXCEPTION TO THIS:

The only exception for me is if your employer matches your contribution 100%.

If your company is saying: Hey, set aside 3% of your gross income each year and we’ll fully match it with 3% of our own, THEN GO FOR IT.

It’s already a 100% return on your money, which beats out any kind of interest rate.

Anyway, the best advice I can give to you? Budget and track your expenses.


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Sherry of Save. Spend. Splurge.

I got out of $60,000 of debt in 18 months using TheBudgetingTool.com. Since then, I have worked 50% of my career (taking 1-2 year breaks), and quadrupled my income within 2 years of graduating, going from $65K to $260K (savings rate = 85%). I could retire today if I wanted, but love my work-life balance as a freelancing consultant in STEM (Science, Technology, Engineering, Math). I also post daily on Instagram @saverspender.

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8 Comments

  1. S
    Sarah

    I’m definitely not doing this.

    I’m prioritizing paying down my mortgage over adding to cash savings (beyond a healthy emergency fund) since that 4% return > the 0.5% my “high-yield” savings account pays. However, my 401K has tax advantages as well as a company match and low fees. It’s also a limited time offer – I can only put in a certain amount per year. Once my mortgage is paid off, I don’t get to go back and put money in, or recoup those tax savings.

    Paying down my mortgage puts my money money into an illiquid asset with a (theoretically, historically) lower rate of return. If I lose my job, I can borrow money from my 401K, but my mortgage company isn’t going to look at all of my extra principal payments and cut me any slack. Even funneling 100% of that money to my mortgage, it will take 10+ years to pay it off (!!). That’s a loss of 10 years of increased returns, plus compounding. Plus it’s 10 years of extra risk.

    Obviously, every situation is different, and I actually agree for non-mortgage debt. And of course I’m American, so I have little understanding of how Canadian retirement funds works. And our social safety nets are not as good.

    Reply
    1. sherry@savespendsplurge.com

      What a great point! I think you Americans also get to write off the mortgage interest against your taxes right?

      We don’t get that here in Canada…. Our retirement funds are similar to yours. RRSP = 401K, TFSA = Roth IRA, RESP = 529

      Reply
  2. D
    Deborah

    I agree with you wholeheartedly. I also disagree with you. I’ll tell you why. I have reached a point in my life where I will be mortgage-free in less than two weeks time (yaay). I have worked away at paying down my mortgage within a relatively short time frame (just shy of 12 years). I carry no other debt (yaay). I also have a fairly healthy retirement plan (yaay).

    Over the course of these 12 years, I have put extensive work into my house (well into the six figures), all while paying down the mortgage. Arguably, you could say that I should’ve put that money towards mortgage, and then would’ve been debt free even sooner than 12 years.
    Could I have paid it down faster, thereby, saving more money? Yes. Could I have saved more more money by not doing any cosmetic things to the house, thereby padding my retirement more? Yes.
    Some of the work into that house was structural (as in it was necessary), some of it was cosmetic, some of it was a combination of both. However, ALL of it was to enhance the value of the house and the quality of my life in that house.
    Could I have purchased a house that didn’t require so much work? Yes.
    But I also chose to live in a centrally located neighborhood with high property values and a really good walk score. Had I not made that choice, then I wouldn’t have what I have now. And there are absolutely no regrets about that.

    It’s not an all or nothing proposition.
    I really appreciated your blog post because I have reached a point in my life where I agree with every single point you made. But there was also a point in my life where I was doing a lot of heavy lifting to get to where I am now, i.e. debt free, mortgage free, padded investment portfolio, etc. I made choices to incur costs on improving the house. In my opinion, it’s all paid off – literally and metaphorically.

    So, there is more than one way to skin a cat.

    Reply
    1. sherry@savespendsplurge.com

      What a GREAT reply. Thank you, you’ve given me more to think about particularly the part about having to live in it anyway and enjoy it. No need to clear it like a mad person if you are not loving it. 🙂

      Reply
  3. Taylor Lee @ Engineer Cents

    In terms of disaster preparedness, I personally feel like having liquidity (i.e. cash in my emergency fund) is much more important than minimizing debt. For instance, if I get laid off from my job, having paid off 3/4ths of my mortgage but having saved no money, I am in a much riskier position than if I had paid off 1/2 my mortgage and have 1/4 in liquid assets. This is because, in instances of crisis (most notably job loss or health scare), home equity is just as inaccessible if not more so than funds in a retirement account or investment fund, and certainly less accessible than cash.

    Reply
    1. sherry@savespendsplurge.com

      I wonder if I could come up with a formula for this.

      Reply
  4. M
    Marie-Josée

    You are right, of course, that job losses and illness or injuries do happen and impact our finances. I think mortgage debt is smart under certain circumstances: namely that the mortgage and ancillary costs represent no more than 25% of net income, plus a six month emergency fund. Most people who don’t own pay rent and that money is lost forever, whereas a homeowner is building equity with that debt. An interesting middle ground is to invest in an RRSP and apply the tax return to the mortgage debt.

    Reply
    1. sherry@savespendsplurge.com

      Well hang on. Paying rent doesn’t mean that you’re throwing that money away. I wrote a post about that: Renting vs. Owning.

      Renting lets you save the rest of that money not put in the mortgage or taxes, and it could be more profitable in the long term to rent versus buying and owning unless you have it in cash to pay 100% without a mortgage.

      Reply

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