Should I Pay Off My Mortgage Or Keep Investing? Finding Our Switch Point

There's been a lot of talk lately about rising bond yields, which may lead to higher interest rates. I saw an article that Canada is expected to raise interest rates three times by mid-2027. News like that doesn't bother me, but it does lead me to reassess our allocation strategy and figure out when it makes sense to shift more of our money toward paying off the mortgage versus continuing to invest. Our current mortgage rate is 3.55% (variable), while our 10-year average rate of return is 8.04% (inclusive of dividends).

Taking things at face value, I should wait until rates are near 8% before shifting, but does that really make sense? Let's explore the math.

Why bond yields matter for your mortgage

Mortgage rates in Canada move on two different dials. Fixed rates are priced off Government of Canada bond yields, so when yields climb, fixed rates tend to follow within weeks. Variable rates follow your lender's prime rate, which moves with the Bank of Canada's overnight rate. Rising bond yields don't change a variable rate directly, but they're often a sign that markets expect higher inflation or higher policy rates ahead.

If those three quarter-point hikes arrive, our 3.55% becomes roughly 4.30%. That's the number I'm planning around.

How you feel a hike depends on your mortgage. With an adjustable-rate mortgage, your payment goes up. With a variable-rate mortgage that has fixed payments, your payment stays the same, but more of it goes to interest and less to principal, which quietly stretches out your amortization. Either way, carrying the debt gets more expensive.

Why 8% is the wrong finish line

Comparing 3.55% to 8.04% feels intuitive, but it lines up two numbers that aren't the same kind of number.

A guarantee versus an average

Every dollar you put against the mortgage earns exactly your mortgage rate, guaranteed, starting the day you pay it. Every dollar you invest earns whatever the market decides to give you. Our 8.04% is what the portfolio did, not what it will do. And also this is over the course of the last 10 or so years. This is not a guaranteed immediate return. Anyone holding US stocks from 2000 through 2009 earned slightly less than zero over the entire decade. If you needed your portfolio to beat your mortgage during that stretch, you waited ten years for nothing.

That means the fair comparison for prepaying a mortgage isn't a stock portfolio. It's a guaranteed investment, like a GIC. Nobody says "I'll only buy a 3.55% GIC once the market stops returning 8%." Investing has to earn more than the mortgage rate to be worth the risk. The real question is how much more.

Taxes decide what 8.04% is actually worth

In Canada, mortgage interest on your home isn't tax-deductible. That makes paying down a 3.55% mortgage a 3.55% after-tax return, no strings attached.

Your investment returns are only fully after-tax inside a TFSA, and roughly so inside an RRSP. In a non-registered account, capital gains are taxed at a 50% inclusion rate and dividends and distributions get taxed along the way. A reasonable rule of thumb is that non-registered returns lose about half your marginal tax rate. At a 43% marginal rate, 8.04% shrinks to about 6.31%, and 6.5% shrinks to 5.10%.

Here's another way to see it. At a 43% marginal rate, a non-registered GIC would need to pay about 7.54% to match the guaranteed, tax-free 4.30% you'd earn by prepaying a mortgage at that rate.

The next ten years aren't the last ten

A 10-year average tells you about the decade you had. The assumptions Canadian financial planners are asked to use for long-term projections have generally put stock returns in the 6.3% to 7.5% range before fees, well below what the last decade delivered.

One more check worth doing - make sure your average is annualized (compounded), not a simple average of each year's return. When returns bounce around, the simple average overstates what you actually earned.

For the rest of this post, I'm running the numbers two ways - at our actual 8.04%, and at a more conservative 6.5%.

The rule - after-tax return, minus a cushion

Here's the framework I landed on. Start with your edge, which is your expected after-tax investment return minus your mortgage rate.

If the edge is 3 percentage points or more, keep investing everything. The expected reward is big enough to justify the risk.

If the edge is under 1 point, send extra cash to the mortgage. You'd be taking on market risk for a sliver of extra return.

Anywhere in between, split it, sliding from mostly mortgage to mostly investing as the edge grows. An edge of 2 points works out to a 50/50 split.

Those thresholds aren't laws of finance. They're a judgment call on how much extra return is worth a decade that could go sideways. If a 20% drop would keep you up at night, raise both hurdles. If retirement is less than 10 years away, raise them too, because a short timeline gives markets less room to recover.

Applied to our situation, here's where the switch points land:

So no, the line isn't 8%. Even if I take our 8.04% at face value, the split starts around 5% and the mortgage wins outright a full point before 8%. If I plan with a more modest 6.5%, our 3.55% rate is sitting right on the line today, and three hikes to 4.30% would put tax-sheltered money at a 60/40 split between investing and the mortgage. For non-registered money, a 4.30% mortgage is already past the point where prepaying wins.

What it looks like in dollars

Numbers on a table are one thing. Here's what the choice does to real money.

Take a $350,000 mortgage with 20 years left, a 4.30% rate after the hikes, and $1,000 a month in extra cash. Path one sends all $1,000 to the mortgage. It's gone in 11.8 years, and from then on the old payment plus the extra $1,000 gets invested every month. Path two invests the $1,000 from day one and pays the mortgage on schedule. At year 20, both households are mortgage-free, so we can compare their portfolios head to head.

Read down the table and a pattern jumps out. As the edge shrinks, the upside of investing shrinks and the downside grows. With a wide edge, you're risking $7,000 for a shot at $144,000. With a thin one, you're risking $39,000 to make $23,000. Investing still wins on paper in every row, which is exactly why "the higher number wins" is a trap.

The split exists for the middle row. At 6.5% in a TFSA, a 60/40 split ends up $35,842 ahead of prepaying if returns show up as expected and only $11,932 behind if they come in at half. It keeps about half the upside of investing everything while cutting the downside by more than half.

Does inflation change the answer?

Yes, but not the way most people assume.

On paper, it cancels out. At 2% inflation, our 3.55% mortgage really costs about 1.55%, and an 8.04% return really earns about 6.04%. Inflation lowers both sides by the same amount, so the gap between them doesn't move. "Inflation makes debt cheaper" is true, but it makes your investment returns smaller by the same amount.

It matters through taxes. In a non-registered account, you pay tax on your whole return, including the part that only keeps up with rising prices. Say your investments earn 4.5% above inflation. At 2% inflation, that's 6.5% nominal, 5.10% after tax at a 43% marginal rate, and 3.10% after inflation. At 4% inflation, it's 8.5% nominal, 6.67% after tax, and only 2.67% after inflation. Same real return, less of it kept. Your TFSA and RRSP don't have this problem, and neither does paying down your mortgage, which is never taxed. Higher inflation tilts non-registered money toward the mortgage.

It matters through your rate type. With a fixed rate, surprise inflation is a gift. Your rate stays put while prices and paycheques rise around it. With a variable rate, you don't get that protection, because the Bank of Canada fights inflation by raising the very rate your mortgage follows.

It matters because bad news clusters. In 2022, inflation surged, the Bank of Canada raised its policy rate by more than four percentage points in under a year, and stocks and bonds fell at the same time. For variable-rate borrowers, the year the mortgage got expensive was the same year their portfolio got cheaper. That's a strong argument against being all-in on either side if your rate is variable. I remember getting hit really hard this year. Our mortgage payments surged by about $1000/month and ended the year with a -9% return. On the plus side - I got a 9% discount.

Inflation doesn't move the switch point on its own. But high inflation, a variable rate, and non-registered investing together should push you toward the mortgage.

When paying off the mortgage early makes sense

Your edge is thin. If your TFSA and RRSP are full and extra cash would land in a non-registered account, the after-tax math gets tight fast, especially in a higher bracket.

Retirement is close. A market drop right before or right after you retire does far more damage than one twenty years out. Walking into retirement mortgage-free also means you need less income each year, which means smaller RRSP or RRIF withdrawals, less tax, and less exposure to the OAS clawback. If you're planning your withdrawals, my drawdown calculator post shows how much this matters.

You wouldn't hold through a crash. A guaranteed 4.30% you keep beats an expected 8% you sell at the bottom. Be honest about how you acted in 2020 and 2022. Personally - I powered through the pain and bought lots of stocks at a discount.

Your renewal is coming at a higher rate. A lump sum before renewal shrinks the balance that gets repriced. Most lenders allow some combination of annual lump-sum payments and payment increases, commonly in the 10% to 20% range, without penalty. Check your contract before sending money. Ours allows up to 20% of the mortgage.

You value lower fixed costs. A paid-off home is one of the biggest levers for optionality. The smaller your required monthly spending, the easier it is to cut back on work, change careers, or step away entirely. That isn't a spreadsheet return, but it's a real one.

When to keep investing

You have a wide edge and tax-sheltered room. Unused TFSA or RRSP room plus a low mortgage rate is the classic case for investing.

Your employer matches contributions. A 50% or 100% match is an instant return that no mortgage rate competes with. Always take the full match first.

You have kids and RESP room. The Canada Education Savings Grant adds 20% on the first $2,500 you contribute per child each year, up to $500. That beats prepaying at almost any rate.

You're in a high bracket now and expect a lower one in retirement. An RRSP deduction at today's high rate, withdrawn later at a lower rate, earns more than the tax-sheltered numbers above suggest.

You care about liquidity. Invested money can be sold and in your account within days. Money sent to the mortgage is locked in the house, and getting it back means a HELOC or refinance, which lenders are least eager to approve right after you've lost your job. Being a single-income family, liquidity has been very important to us for the past 10 years. This will matter less when my wife finishes her second degree and re-enters the job market.

When to do both

Your edge lands in the middle. That's the split zone, and it's where most of us are once return expectations get realistic.

Your rate is variable and hikes are forecast. A split hedges both outcomes. If rates climb and markets stumble, part of your money earned a guaranteed return. If rates stall and markets run, most of it is still invested.

You contribute to an RRSP. Contribute during the year, then put the tax refund on the mortgage. It's a built-in split that doesn't require any extra cash flow.

You're genuinely unsure about future returns. Splitting is the choice you're least likely to regret. You'll never be fully right, but you'll never be fully wrong either.

A few other scenarios worth checking

Handle the basics first. Before either option, build an emergency fund of three to six months of expenses and pay off any debt charging more than about 6%. A car loan at 7% or a credit card at 20% beats both your mortgage and your portfolio as a place to send extra cash.

Locking in is another lever. If your real worry is rising rates, converting your variable mortgage to a fixed term is an option, and many lenders allow it without a penalty, or for a minimal fee. Just remember that fixed rates are priced off the same bond yields making the headlines, so locking in isn't free insurance.

The Smith Manoeuvre changes the math. Some Canadians prepay the mortgage and re-borrow that principal through a readvanceable HELOC to invest in a non-registered account, which can make the interest tax-deductible. It adds leverage and complexity and isn't for everyone, but it's worth knowing that "pay down or invest" isn't always either/or.

Where that leaves us

We're not changing anything today. At 3.55% with our money going into tax-sheltered accounts, we're still in investing territory using our historical return. But I'm not waiting for 8% either. Using our own numbers, the split starts around 5%, and if the hikes arrive and I plan with more modest return expectations, it starts a lot sooner than that. The plan is to rerun this every time our rate moves, not every time a headline does.

Run your own numbers

The calculator below uses the same framework from this post. Enter your mortgage, your extra monthly cash, where you invest, and how you handle market swings. It shows whether to invest, prepay, or split (and exactly how much goes where), marks your personal switch points on a rate scale, and compares each strategy if returns show up as expected or come in at half. The defaults are the example above, so you can start there and swap in your own numbers.

This post is for educational purposes and isn't financial advice. Returns aren't guaranteed, and your lender's prepayment privileges and penalties will affect what's possible. Consider speaking with a fee-only planner about your specific situation.