Total Monthly Payment  -  $750.00  -  That's it !  You almost don't even need a calculator!



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An in-depth discussion of interest-only mortgages and interest-only mortgage loans in Canada is very different than the same conversation in the USA.  Where interest-only payment methods were formerly used for income leverage purposes -- using the same income stream to buy a home while accumulating other assets -- today's loans aren't being pitched only to well-to-do, sophisticated investors. While "cash- flow" purposes are still common, another audience with a different need has developed.

An Interest only mortgage can be an excellent choice for some borrowers. They are designed to offer the lowest payment possible as you are not paying anything toward the principal in your normal monthly payment. Because of the lower payment, the interest only loan may mean that you can buy more home than with a fully amortizing mortgage. Of course, you may make additional payments toward your principal balance at any time.

The interest only product was originally designed for individuals whose income is cyclical. For example, an individual who is a sales executive with a relatively low base salary but commission or bonus payouts quarterly would benefit from an interest only mortgage. You would have the lowest possible payment during months when no bonus is paid and you would be able to make contributions to the principal balance when the quarterly bonus is paid. However, I am seeing individuals in many situations choosing this option as a method of lowering their payment, sometimes significantly.


7 Reasons Why You Should Have An Interest Only Mortgage

Why would you want to pay the interest to the bank and the principal to your self?  First reason is to lower your monthly mortgage payment by half or more for most people.  Second when you pay the principal to your self you can put the money to a better use like paying off debt, investing in real estate, buy RRSP for retirement, or your childrens education.  Third you pay less interest each month.  Fourth more of your payment will go to principal.  Fifth when you pay principal on your mortgage you don't receive interest on your money.  Sixth over time the buying power of your principal will be eaten away by inflation.  Seven a dollar in your hand today is worth more than a dollar tomorrow.

The chart below shows a typical $300,000 mortgage at 5.10% with principal and interest payments of $1762 per month compared to the same $300,000 mortgage with Interest-Only payments.  You can see by the green line that the mortgage will be paid off in 25 years based on $1762 per month.  The red line is the Interest-Only mortgage payment that is $875 per month.  The two upward curving dark blue lines is the growing principal of the Interest-Only mortgage.  About $877 a month is paid to your self in a RRSP invested in corporate bonds or GIC for example.  This is how I would set up your Interest-Only mortgage.  If you have $10,000 debt or more I would first pay off the debt than buy RRSP.  An RRSP is good place to pay your taxes to, get a return, and recieve a tax deduction




Pay Off Debt, Increase Cash Flow. Buy RRSP, Lower Payments 

Few families have the cash to make maximum RRSP contribution, mortgage prepayment and pay their credit cards off every month. 

The conventional wisdom is to buy RRSP, pay down the mortgage with the tax refund and pay what you can on your credit cards.  The best strategy is to pay off your credit cards than sock all the extra cash and tax refunds in an RRSP and leave the mortgage alone.  Interest from debt eats up any spare cash a family has.  It takes about seven years to pay off a $10,000 credit card debt.

How does a family with a $300,000 mortgage/5.00%, $10,000 in debt (Canadians owe 105.2% of personal disposable income) and little retirement savings (25% of eligible Canadians buy RRSP) get rid of the debt and start saving?  Start by switching to an Interest-Only Mortgage based on Prime -.75 currently 3.00%.  The principal ($995) can be used to pay off your debt. Your debt will be paid off in one year instead of seven.  Next step is your RRSP retirement fund.  Use the same $995, no longer required to pay down the debt, to max your RRSP.

Example:  Bob and Shirley are 45 years old in a 35% tax bracket, save $4000 a year, and return on investment is 6.00%.  Both homes have a mortgage of 150,000 @ 5.00%, for 25 years with payments of $872. 

Bob’s strategy is to pay his home off using his spare cash of $333 per month.  Bob pays his home off by age 59.5.  His $1206 ($872 + $333) a month goes to RRSP until age 65.  At retirement he has a free and clear home and RRSP of $136,900. 

Shirley switches to an Interest-Only Mortgage.  Her spare cash ($333) and mortgage payment savings ($497)  is invested into a RRSP.  Her RRSP at age 65 is $485,000.

On retirement day at age 65 Bob and Shirley sell their homes for $500,000.  Bob’s wealth is $500,000 plus $136,900 for a total of $636,900.  Shirley has $350,000 after paying off her original mortgage plus $485,000 in RRSP for a total of $835,000. 

Bob & Shirley’s Retirement Life Style
Using a 2.00% inflation rate Shirley’s $835,000 will give her an income equivalent to  about $37,500 and $29,000 for Bob. Remember the money has to last up to 20 years.


Buy RRSP For 10 Years
Invest $12,000 a year in RRSP at age 35 for 10 years ($120,000) than stop your RRSP grows to $869,500 by age 65. Wait until age 45 to invest $12,000 a year for 20 years ($240,000) you will have $650,000 at age 65.  Wait until age 55 to invest $12,000 a year ($120,000) in RRSP and you will retire with $224,700. 

assumes 7.00% return, 30% tax bracket, RRSP tax deductions are reinvested

If you don't have $12,000 spare cash you might consider an Interest-Only Mortgage to free up the money so you don't have to borrow more money for your RRSP.

But I Will Only Be Paying Interest
But your 18.9% Visa will be paid off, so will your 24% store cards and 28% gas cards.  You can pay principal if you wish plus 20%.

What Happens If  The Rates Go Up
The interest only rate of 3.00% would have to rise to 7.00% to match the payment of a $300,000 mortgage payment @ 5.00%.

What If My Home Value Goes Down
If real estate fell 25% wouldn’t you want your money collecting 5.80% in an RRSP instead of 0.00% in a mortgage?  The value of your home will rise and fall with real estate market conditions.  An Interest-Only Mortgage gives you the option of securing a return on your money.

What If I Lose My Job
You have cash reserves in your RRSP for an emergency.  Refinancing your home while unemployed will be impossible.

How Come This Works
This works when the mortgage rate (3.00%) is less than the investment return (6.00%)
Five-year rate is 73.3% premium to prime rate mortgages according to National Post.

RRSP Maximum Contibution - The maximum annual contribution limit is currently $14,500. It is scheduled to increase to $15,500 in the year 2004 and then to $16,500 in 2005. Your allowable RRSP contribution for the current year is the lower of: 18% of your earned income from the previous year, or The maximum annual contribution limit for the taxation year, or The remaining limit after any company sponsored pension plan contributions