Clients often ask the following question: “Should I use my excess funds to pay down my mortgage, or to contribute to my RRSP?” It’s a great question, and as with most issues in financial planning, there is no definite answer.
Paying down the mortgage is the “risk-free” option. If $1,000 is applied towards the mortgage, there is a guaranteed savings of the mortgage interest on that amount.
Alternatively, if $1,000 is added to a retirement portfolio, there is no “guaranteed” return. Historically, the Canadian (TSX) and U.S. markets (S&P, Dow Jones) have returned around 8% in the long-run. We project about a 6-8% rate of return for our client’s long-term growth-oriented portfolios.
Mortgage rates are very low these days, somewhere around the 2.5% mark for a five-year fixed rate. This makes the “break-even” point for an investment portfolio to beat mortgage savings fairly low. Without talking about interest compounding or taxes, if the investments return more than 2.5%, then they beat out any mortgage savings strategy.
Our favourite strategy is a hybrid one. Invest long-term money in an RRSP and use the ensuing tax savings to pay down the mortgage. When families can maximize RRSP contributions, they can create significant tax savings which can supplement retirement income plans, as well as reduce mortgage debt. The tax savings created by an RRSP contribution can free up “new money” to be used to pay down mortgage debt. This quickly increases family net worth.
As we say, every situation is unique and depends on your mortgage interest rate and the anticipated return on your investment. Please call or e-mail us and we will be happy to work through the numbers to give you the best advice for your circumstances. We’re here to help you!