Choose the goal with the bet­ter ROI

Weigh the pros and cons of pay­ing off mort­gage ver­sus mak­ing RRSP con­tri­bu­tions


Plagued by crip­pling house­hold debt, mil­lions of Cana­di­ans are torn be­tween sav­ing for re­tire­ment and pay­ing off the mort­gage, the largest of all debts. For the vast ma­jor­ity of Cana­di­ans, the op­tion of do­ing both is just out of the ques­tion.

Ac­cord­ing to the lat­est Sta­tis­tics Canada fig­ures, the debt-to-in­come ra­tio among Cana­dian house­holds has jumped to 166.9 per cent of dis­pos­able in­come, a record high. No doubt the bulk of this debt is re­sult­ing from unchecked bor­row­ing led by home pur­chases.

For those living pay­cheque to pay­cheque, choos­ing be­tween build­ing re­tire­ment sav­ings in an RRSP and wip­ing out the mort­gage debt seems like a bat­tle they can never win. So what are they to do? There are two ways of look­ing at it, says Marie DeLau­retis, a Cal­gar­y­based cer­ti­fied fi­nan­cial plan­ner.

“One way to think is, ‘I can earn more on my in­vest­ments than my cur­rent low mort­gage in­ter­est rate,’ ” she says. “The other is, be­cause mort­gage rates are so low, you now have greater op­por­tu­nity to pay your mort­gage bal­ance quicker as fewer funds will be used to pay in­ter­est costs.”

The higher your in­ter­est rate, the more will be go­ing to in­ter­est ex­penses and not home eq­uity, goes the ar­gu­ment.

Many peo­ple, how­ever, only con­sider the short-term im­pli­ca­tions. Cyn­thia Kett, a prin­ci­pal with ad­vice-only firm Ste­wart & Kett Fi­nan­cial Ad­vi­sors Inc. in Toronto, says peo­ple should be think­ing about their fi­nan­cial plan­ning as a whole.

“Cash man­age­ment, tax plan­ning, in­vest­ment plan­ning and re­tire­ment are the key ones in this case,” she says. From a cash man­age­ment per­spec­tive, the ques­tion is how dis­ci­plined are you?

Some peo­ple use a home pur­chase, fi­nanced by a mort­gage, as a form of forced sav­ings, Kett says.

“If they pay down their mort­gage sooner, will they use that ex­tra cash flow to dili­gently save for re­tire­ment later?” she says. “This is key, be­cause if all they have in re­tire­ment is a fully paid-for home and OAS/CPP, they’ll have to sell the house to fund their re­tire­ment.”

Kett says for peo­ple who lack that dis­ci­pline, it may be bet­ter to con­trib­ute to their RRSP. How­ever, she adds, for more dis­ci­plined folks, pay­ing down the mort­gage may make more sense. “Once mort­gage debt is paid off, there will be sig­nif­i­cant free cash flow avail­able for re­tire­ment and other pri­or­i­ties,” she says.

In the cur­rent low in­ter­est rate en- vi­ron­ment, pay­ing off a mort­gage can be a more pru­dent choice.

“If we con­sider pay­ing down the mort­gage as a proxy for a safe fixed­in­come in­vest­ment which might only yield 2 per cent, the mort­gage rates of re­turn look pretty good,” Kett says. “Even in com­par­i­son to eq­uity in­vest­ments — the pre-tax mort­gage rate of re­turn is ex­cel­lent be­cause it’s guar­an­teed. Eq­uity re­turns are un­pre­dictable and may be neg­a­tive.”

Pay­ing down the mort­gage, in this in­stance, wins hands down.

Emo­tions can also ex­ert strong in­flu­ence af­fect­ing peo­ple’s in­vest­ment de­ci­sions. The in­di­vid­ual risk tol­er­ance and ca­pac­ity for risk are im­por­tant con­sid­er­a­tions, DeLau­retis says. “Peo­ple pre­fer to avoid losses to mak­ing gains,” she says.

For that rea­son, when de­cid­ing to make a pay­ment to­ward your mort­gage ver­sus an RRSP con­tri­bu­tion, an in­di­vid­ual must con­sider re­turn on in­vest­ment. In the case of mort­gage, the re­turn must be cal­cu­lated in terms of how much money is saved on in­ter­est over the life of the mort­gage. DeLau­retis uses sim­ple math to il­lus­trate her point. For ex­am­ple, she says, with lump sum pay­ment of $25,000 made at the be­gin­ning of the mort­gage term could re­sult in guar­an­teed in­ter­est sav­ings of $26,394, as­sum­ing 3-per-cent mort­gage in­ter­est rate on a mort­gage amount of $500,000, to be paid over 25 years.

In ad­di­tion, there’s the con­sid­er­a­tion of “the po­ten­tial for eq­uity ap­pre­ci­a­tion that is also tax free, when com­pared to mak­ing the RRSP con­tri­bu­tion with non-guar­an­teed rates of re­turns,” DeLau­retis says. Re­mem­ber, cap­i­tal gains on a home are tax-free, be­cause of the prin­ci­pal res­i­dence ex­emp­tion.

That’s not to say the RRSP doesn’t have its own ben­e­fits, par­tic­u­larly for higher in­come earn­ers.

“If the in­di­vid­ual is in a high tax bracket now, they will be in a lower tax bracket when they re­tire or when they with­draw the funds — other than for the Life­long Learn­ing Plan,” Kett says.

“(If ) they plan to leave the con­tri­bu­tion in the RRSP for some time (al­low­ing them to grow in value), then con­tribut­ing to their RRSP may be the best choice.”

But for those who can’t af­ford to do both, the psy­cho­log­i­cal ad­van­tage of be­ing debt-free sooner trumps con­tribut­ing to a re­tire­ment sav­ings plan.

“If pay­ing down the mort­gage is a source of hap­pi­ness, that is a good rea­son to make it a pri­or­ity,” Kett says, not­ing it’s “the least risky op­tion” and one that of­fers “great rates of re­turn, with no risk.”

After all, who wouldn’t love the feel­ing of be­ing debt-free sooner, DeLau­retis says.

“We must take into ac­count peace of mind achiev­ing a goal or steadily work­ing to­ward that goal,” she says. “Espe­cially, if it helps to avoid loss, bal­loon­ing debt, or the ef­fects of un­con­trol­lable eco­nomic fac­tors such as job loss, in­creas­ing mort­gage rates and life-chang­ing events in­clud­ing ac­ci­dents, ill­ness and death.”


You made one of life’s big­gest pur­chases — a home. But here comes the next round of fi­nan­cial de­ci­sions.

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