Mortgage vs RRSP has been a continuous debate in Canada when it comes to financial planning. Do I pay my mortgage or contribute to RRSP? And what about TFSA? Unlike the US, in Canada the interest on mortgage is not tax deductible, so this makes our decision somewhat difficult.
There really isn’t a right answer, it all depends on your situation and comfort level, but let’s take a look at the pro’s and con’s of couple of cases. We will leave TFSA out of this debate as it will only make things more complicated.
We basically have 3 options:
Option 1- Pay off mortgage with any extra money available
1. Debt Free sooner
2. Save on interest
3. Guaranteed rate of return (your mortgage rate)
1. No retirement savings
2. Lose out on compounding
3. Lose out on tax refund
There are some who hate having any kind of debt, if you are among them than paying down your non-tax deductible mortgage would be the way to go. Although you will be losing out on compounding and tax deferred growth in your RRSP, which can be higher than your interest savings on your mortgage, you will have a guaranteed rate of return and reduce your debt load.
Option 2 – Maximize RRSP
1. Build early savings enjoy compounding
2. Potential for good retirement fund
1. Pay interest on mortgage
2. No guarantee for rate of return
This is an option for those who don’t mind debt and want to take advantage of compounding and potential gains in the market. This strategy has a potential of higher return than your mortgage but there is no guarantee of any kind. If you don’t mind debt, can handle some market volatility and believe there is a growth potential in the markets this would be the choice for you.
Option 3 – Maximize RRSP and Pay down mortgage with Tax refund.
1. Save for retirement and Pay down debt
1. Longer to pay off debt
This is probably the best option, you would be saving and taking advantage of compounding and at the same time you’d be able to pay down debt and save on interest. Unless you really hate debt this option would work well for everyone.
Each strategy has its benefits and setbacks’, so picking the right one is up to ones preference and comfort level there really isn’t the right choice. In general if you believe that your RRSP can return a higher rate than your mortgage interest rate then maximizing your RRSP would be the sensible thing to do. However if you don’t believe your investments will return a higher rate then your mortgage rate, then paying down debt will provide you with a higher rate of return.
Although each choice is as good as the other there is also human psychology in play here. Paying down debt is not as psychologically satisfying as building and investment portfolio is, although it can be just as good of a strategy.
Note: If paying down debt is a priority to you, you could also make payments bi-weekly instead of monthly without costing you anything extra. This will reduce your amortization by 4 years or more and can save you quite a bit on interest, you would be paying half of your monthly payments every other week. And if you combine this with any of the options mentioned above, you would be in a very healthy financial position.
My personal opinion?
Option 3; maximize RRSP and use tax refund to pay down mortgage and make bi-weekly payments, this to me is a great strategy and I can achieve two goals at the same time.
The mortgage vs RRSP debate will likely go on for yeras, but is your preference? Any other strategies you suggest?