RRSP, Pay Down the Mortgage, or Both?
Well, it's that time of year. RRSP season is upon us with the deadline for your contribution fast approaching - March 1st. The classic question I get from many is, should I invest in an RRSP, pay down on my mortgage principal or both?
I must preface that if you have any high interest credit card debt, that should be the first focus. With those rates hovering around 11-29% interest, it always makes more sense to get rid of that debt first.
Let's assume that you doesn't have any other debt and are simply wondering if the RRSP is the better way to go or, should you fast track paying down your mortgage?
Read on to find out which is the better option, or, if you should opt for a blend of both.Assumptions:
- Mortgage of $250,000
- 4% interest rate
- 5 year fixed term
- 25 year amortization
- Bi-weekly payments
- $6,000 a year to invest or pay down on the mortgage principal for 15 years
OPTION 1: Pay down the mortgage. Make annual anniversary payments of $6,000 on the mortgage principal
- Savings of $62,017.15 (assuming rates remained the same for 15 years)
- Would reduce the amortization down from 25 to 15.3 years
- Here's the mortgage calculator for your own situation: http://www.rbcroyalbank.com/products/mortgages/mortgage_calculators.html
OPTION 2: Invest in an RRSP and use the tax refund to pay down on the mortgage
- Jefferson earns $50,000 a year and lives in Ontario
- If he invests $6,000 into an RRSP, he should expect a refund of $1,874.40 (check your own province and income level with this calculator http://www.oecu.on.ca/tools/rrsptax_calc.htm )
- If he applies his tax refund to his mortgage principal annually (using the same criteria from option one), he'll save $25,852.24 (assuming rates remain the same).
- If he invests $6,000 a year for 15 years into an RRSP assuming a rate of return equal to his mortgage rate (not factoring in inflation), his RRSP is estimated to be worth $125,127.81 at the end of 15 years (here's a calculator that estimates your RRSP savings growth http://www.oecu.on.ca/tools/rrspsavings_calc.htm )
- Add the RRSP amount to the interest savings on the mortgage and that equals $150,980.05.
OPTION 2 is the clear winner!
By Jefferson investing in the RRSP and using the tax refund to pay down his mortgage as opposed to simply using his investment to pay down on the mortgage, option two is the clear choice by $88,962.90.
Of course, if Jefferson were in a higher tax bracket or if his RRSP earned more than the projected 4% return, option two looks even better. However, should rates increase during the lifetime of his mortgage, he'll want to re-examine the numbers.
Mortgage freedom is a very worthy goal, however, creating a retirement fund while one pays off their mortgage is a prudent strategy. Check the calculators for yourself and see which option makes the most sense for your financial situation.
Kelley Keehn is a financial expert, author, speaker and host of W Network's Burn My Mortgage. She's also a weekly contributor to the Globe and Mail. For more information, visit www.kelleykeehn.com.
Do you have a money question? Drop Kelley a line at firstname.lastname@example.org. Do yo