One of the most frequent questions I am asked is whether one should pay down their mortgage or invest in their RRSP’s. Although I am a big believer that financial freedom is achieved first and foremost by being mortgage free, there are a few factors that play into the equation such as, the return on your investments, your marginal personal tax rate and your current mortgage rate.
Why are these factors important? Well the higher your personal tax rate is the greater your tax savings will be on your RRSP contributions. So if you are in a high tax bracket, contributing to your RRSP may make more sense than paying down your mortgage. However, if interest rates are rather high, potentially higher than what you might return on your investments then paying down your mortgage first may make more sense. And visa versa, if the rate of return on your RRSP’s is consistently higher than your mortgage interest rate then investing in the RRSP is the better choice.
These are not the only factors to consider. A suitable decision can only be made after all your financial circumstances are known, such as
- How far off is your desired retirement date?
- How many years do you have left to save for retirement once your mortgage is fully paid down?
- What will your current sources of retirement income be i.e. RRSP’s, company pension plan & Government pension plan?
- What is the type of lifestyle you want in retirement and what will it cost?
- How many years in retirement will you need to fund ie. 20 years, from age 65 to age 85?
If you make paying down your mortgage your priority, you’ll save a lot of money in the long run on interest costs and be debt-free sooner. Unfortunately your retirement income may be at risk. However, if you decide to invest in your RRSP’s and forgo any additional payments to your mortgage, you will pay more in interest costs and be no closer to owning your home. You will however, have the benefit of tax-deferred, compound growth and the peace of mind that comes from knowing that you can live the lifestyle you desire in your retirement.
Tips to consider
- Contribute the most you can each year to your RRSP. Consider setting up an automatic monthly savings plan. The ‘pay yourself first’ method of investing will help ensure that you are consistent with your contributions to your RRSP plus you will get the benefit of dollar cost averaging. You can then use the tax rebate to either invest back into your RRSP or use it as a lump sum payment down your mortgage.
- Make sure that your mortgage amortization is no more than the numbers of years you have left until you retire. For example, if you plan on retiring at age 65 then you should ensure your last mortgage payments is made before this date. Ask your banker for help with this.
- Make bi-weekly mortgage payments instead of monthly payments. Using this strategy will cut years off your amortization as you are actually making an extra payment each year.
- If you take out an RRSP loan at prime or prime plus one, consider using your tax rebate to pay down higher rate loans. For example, if you take out a $10,000 RRSP loan at 4.5%, use the tax rebate to pay off your 18% visa bill. Then make your scheduled monthly regular payments to the RRSP loan.
Whether you decide to pay down your mortgage or invest in RRSPs, in the end both are good strategies that focus on paying yourself first. Although I usually advise clients to do both – contribute to your RRSP and pay down your mortgage (using your tax rebate). Start early and be consistent and you should have a mortgage free home and money in the bank by the time you hit retirement. With proper planning and determination you can achieve both.
Rhonda Sherwood, CFP. FMA