Pay Off Mortgage or Invest in RRSPs
You’ve worked out a budget and, by sticking to it, have some extra money to play with at the end of each month. So what makes more sense – invest it in your RRSPs or pay down your mortgage?
This question is a very common one among Canadians and the right answer is never that black and white. To help you make the decision for yourself, let’s look at the pros and cons of each strategy.
Putting this extra income against your mortgage will certainly help you get mortgage free (and debt free) much more quickly. Each mortgage payment you make is a combination of interest owing and capital reduction but in the early years of your mortgage especially, the vast majority is going to interest. Any “over contribution” is going entirely against the capital and cuts the length of time and overall interest paid dramatically. For a typical mortgage with a 30 year amortization, one extra payment per year could knock approximately 5 years off the repayment schedule and 15-20% less interest would be paid!
Having said all that, there is a strong case to be made for investing the extra amount in your RRSP as well. If you take this spare income and put it into an RRSP account, not only will that money grow “tax deferred” each year until you need it, you will also receive a tax credit for the contribution amount. This credit can result in a nice big refund come tax time. The key here is making sure that you use that refund wisely – it needs to be put back into your investment account to make real sense. If you’re opting for this route, the many years of compounding in your investments can build up a sizeable nest egg ready to fund your retirement at about the same time your house is mortgage free.
With ultra low interest rates, the option of putting money in your investment account is looking even more attractive to many these days. If you’re mortgage is locked in at a great rate around 3%, tax deferred growth in your investment account at 5-6% looks even more attractive. Add the tax refund into that equation for further compounding and on paper at least, it seems like the answer is clear. Like most things however, it’s not that simple. Long term rates of return on your investments and the mortgage rates you’ll be paying down the road are not guaranteed and you need to evaluate the risks of each.
So which plan makes sense for you? You need to consider your personal situation, risk comfort and debt loads. If you’re carrying high interest debt on a credit card or other loan, most would agree that needs to be wiped clean first. Once you’re down to only the low interest loans, a blended strategy may be the best solution. You might take ½ of the extra income and put it towards each goal or you may decide to put the extra funds into an RRSP and then put the tax refund against the mortgage each year.
As mentioned above, everyone’s situation is different and should be reviewed properly by a Certified Financial Planner to create a plan that’s right for you. Regardless of which of these options you choose, the good news is that you’re working towards a stronger financial future and a stress free retirement!
NOTE: Insurance products provided through multiple insurance carriers.
Mutual funds products are offered through Investia Financial Services Inc.