Tax season is just around the corner, and with it comes THE question: put money into an RRSP account or drop a lump sum payment on your mortgage? The answer? Not as complicated as you might think.
Experts agree, before doing anything, getting rid of any and all personal debt is job number one. In other words, go from worst to first. And by worst, we mean the highest interest rate you have on revolving credit. So, that credit card you own with the 19% interest rate and monthly statements you keep ignoring? That would be a good place to start.
The reason is simple, as accountant David Trahair explains to CPA Magazine, “No portfolio today is going to beat a 19% annual rate of return after taxes.”
So, what happens when credit card debt is not a problem and the biggest debt is essentially a mortgage with a historically low rate? Well, with ongoing mortgage rates set at prime plus 1 for a total just shy of 4%, the answer isn’t as easy. Low mortgage rates mean borrowing money isn’t expensive. So the temptation to invest instead of paying the debt is understandable. But it’s also the wrong way to look at it, says CPA Cynthia Kett to The Globe & Mail, “If you have a mortgage balance that will need to be renewed upon maturity, think about the interest savings based on the renewal rate, not the current rate.”
So, assuming that mortgage rates take a 5% hike in the coming years, a scenario most experts agree is a definite possibility, the balance then tips in favour of paying the mortgage down faster. Kett calculates that avoiding the investment option could translate into a guaranteed pre-tax rate of return equivalent to 7.69%. And this is simply because reducing the principal amount allows savings on future interest and also on the tax paid on that interest.
Now, if deciding between the two is still giving you a minor financial headache, we’ve got a third solution for you. Make the RRSP contribution and use the tax refund to pay down the mortgage. However, even with this option there are still many factors at play, such as the expected rate of returns for a portfolio, the growth of the principal amount and the potential increase of mortgage rates.
So, if you’re looking for a decision that will be anything but complicated, may we suggest opening a Zag Savings account. Where right now you’ll get 2.5% interest. Sign up here.