Finding the Balance

Do I pay down my mortgage or invest in my RRSP?

Over the years, this has been a popular topic at client meetings so I thought I would share some of my opinions on the matter. The decision to pay down your mortgage or invest in an RRSP comes down to a few different factors; interest rates, rate of return, and your current tax bracket.

  • Mortgage Balance    $200,000
  • Interest Rate              4.49% (10 year locked-in rate as of Jan/2012)
  • Rate of Return           6%
  • Term                           25 Years
  • Tax Bracket                35%

Question: Over the next 25 years should I contribute $300/month into my RRSP or increase my mortgage payment?

Using a calculator and the above figures, a 25 year mortgage at $200,000 with a 4.49% interest rate, the monthly payment would be $1,106/month.If you added $300/month to the mortgage payment ($1,106 + $300) you will be mortgage free in 17 years.

*For simplicity, this assumes that the mortgage rate stays at 4.49%

Over the next 8 years, using the assumption that our tax bracket position remains the same, if you were to contribute $1,406/month in an RRSP and reinvesting the income tax savings back into the plan ($492/month) you would have approximately $233,140. 

On the other hand, here is what the calculation would look like if you contributed $300/month to an RRSP while paying your mortgage off over 25 years.

  • Contributing            $300/month
  • Tax Savings            $105/month
  • Years                       25
  • Rate of Return         6%
  • TOTAL                      $280,662

Using this scenario, you would be $47,522 better off contributing to an RRSP.

Before jumping to any conclusions, we must look at another alternative. In the above illustration the mortgage interest rate was lower than the rate of return used in the investment calculations.

Check back soon, and we will post Part 2 of ‘Finding the Balance’ which will look at using a higher mortgage interest rate.

 

Thanks for reading!

Bryan Bye, CFP