I have been asked many times which is better? Paying down the mortgage or contributing to your RRSP…
If only there was a simple answer, do this or do that! I think there is room for both but that would depend on who you talk to and how you manage debt.
We are in the midst of the lowest interest rates in years and because of this, the mortgage rates have followed suit. In the 80’s when interest rates were hovering in the 20% range and mortgage rates were outrageous, I would have told you to pay down your mortgage no questions asked.
With the average discounted mortgage rate hovering around 2.7%, you’d think prioritizing your RRSPs over your mortgage would be a no-brainer, right?
Not necessarily. If the historical rate of return of 10% applied to today’s market then the dilemma would be solved. But the markets have changed. A well-diversified, balanced portfolio (typically 60% equities and 40% fixed income) can return a 5% guaranteed base (within some portfolios).
When it comes to the Mortgage vs. RRSP debate I believe there are three simple questions you should ask yourself:
1) Are you a saver or spender?
Can you resist the last cookie in the package, or stop yourself from going for seconds at the buffet. The real question is whether you are a disciplined saver.
If, for instance, you paid off your student loans and then used that surplus of cash to invest in your retirement, or to save for a down payment on a home, then you, my friend, are a disciplined saver. You would benefit from paying off your mortgage first.
However, if you bought a car and went on a vacation once you had a bit of extra cash after paying back your student loan, then paying off your mortgage—a non-deductible debt—may not be in the best plan of attack because you are a spender. You should probably contribute to your retirement.
2) Are you worried about Debt?
What keeps you up at night? And be honest. If it’s the idea of having debt, then pay down your mortgage first. If you lose sleep at the thought of not having enough money in your retirement years, then contribute to your RRSP first.
3) Have you done the math?
If the interest rate on your mortgage debt is 2.5% higher than the average annual return from your retirement portfolio then ignore your RRSP and pay down your debts.
Keep in mind, that the average annual rate of return for a balanced portfolio with a guaranteed base of 5% (on some portfolios), is only a couple of percentage point higher than most mortgage rates these days.
Every investor should prioritize his or her debts. Pay off high-interest rate credit cards first, and then move to loans and lines of credit, then your lower-interest rate mortgage. There is good debt and bad debt; good debt is a debt with an appreciating asset attached to it such as a home. Bad debt would be High-Interest Credit cards, Unsecured Lines of Credit, and High-Interest Loans, which are attached to a liability.
By thinking about these three questions you can determine whether paying off, your mortgage is the right move for you, or if you should be investing in your retirement fund.
If you’re still in doubt try a Mortgage vs. RRSP calculator. I have chosen this one by Empire Life. It is simple to use and requires no sign in or login details. You must be honest with your input of values to find any benefit in the process.
In my next article, I will show you how you can potentially pay down your Mortgage by investing into your RRSP.
As always you can contact us at henleyfinancial.ca
If you would like information regarding a 5% guaranteed base return during this volatile time in the market don’t hesitate to contact us as we are happy to help you save for the future.