Jason, 45, and Linda, 42, Mississauga
Years married: 3.5 years
Annual household income: $180,000 (mostly his)
Principal on mortgage: $450,000
Interest on 5-year fixed rate: 3.5 per cent
Amortization period: 25 years
Current monthly mortgage payment: $2,247 (paid weekly)
With a household of four kids aged 11 to 21 and his small auto-parts manufacturing company, this couple is used to being decisive. But when it comes to securing their future, they're stuck - should they put their extra cash into paying off their mortgage sooner, or pad their RRSP nest egg (and get a juicy tax break)?
HE SAID: PAY DOWN SOME PRINCIPAL
We've got $5,000 to invest, and we want to do the most responsible thing. I say we put it into paying down the principal on our mortgage. We've got our interest rate of 3.5 per cent locked in for the next four years, but then what? Who knows what rates will be at then - they could double. No matter what happens, putting money toward your mortgage is always a safe bet, right? An RRSP is important for our future, but so is getting the house paid off. We're gung ho on doing that within 15 years - and we pay our mortgage weekly to accelerate it. Besides, any tax refund we would get from investing in the RRSP would be too tempting for me - I'd want to blow it on a trip or something. Linda would have to rip the cheque out of my hands.
SHE SAID: PAD THE NEST EGG
Of the two of us, I'm the saver and Jason's the spender. I absolutely hate debt, and it eats away at me - I don't even carry a balance on my credit card. So I'd normally be inclined to put any spare cash we have into the mortgage. But in this case, it's a no-brainer: Putting the $5,000 into our RRSP would turn it into $7,000 - we'd get $2,000 back from the government if we took the tax break at the highest income bracket, and we could put that toward the principal on our mortgage. We'd still have the $5,000 stashed away, and we'd get a nice return by the time we retire. It's very satisfying to see your nest egg grow.
THE ADVICE: GROW THAT NEST EGG
Financial expert Kelley Keehn
Sorry, Jason, but generally speaking, it makes more sense to invest in an RRSP and use the tax refund to pay down the mortgage principal:
Scenario 1: Put $5,000 annually on your mortgage principal for 15 years. With this strategy, you'll reduce your amortization down to 18 years and you will save $43,681.48 in interest.
Scenario 2: Put $5,000 into an RRSP and use the $2,320.50 tax refund to pay down on your mortgage principal for 15 years. Using a very conservative rate of return of 3.5 per cent (the same as your mortgage) for the RRSP, that would equal $100,022.83 in 15 years. Applying the tax refund to your principal would add up to an additional savings of $22,351.58 and reduce your amortization down to 20.1 years. Together, that's $122,374.41 - a difference of $78,692.93 over the first scenario. This option looks even better when you consider that a balanced RRSP with moderate risk should earn more than 3.5 per cent over a 15-year period.
Of course, not every financial situation is solved strictly by the numbers.
In both examples above, we assumed that rates remain constant. But without a clear crystal ball, no one can know with certainty where rates will go and when. So you both need to understand your risk tolerance with both your mortgage and RRSP and other factors. For example, do you both have pensions that would make investing in an RRSP a tax deterrent at retirement (because of the extra forced income from a RRIF)? Invest in a fee-only financial planner who will assess your entire picture.
Then there's Jason's need for forced savings. Your comment about blowing the tax refund is something I hear often. Don't think of your refund as found money to be blown. It's your money - which the government is now returning to you, without interest. If you can resist the urge to spend it foolishly, I vote with Linda.
Kelley Keehn is the host of W Network's Burn My Mortgage.
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