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investor clinic

My Web video about the benefits of paying down one's mortgage versus contributing to an RRSP generated tens of thousands of views and sparked a vigorous debate in the online comments section.

That's great.

What's not so great is that, in their zeal to shoot holes in my thesis, some readers resorted to misleading math. One reader, for example, suggested that if the interest rate on the mortgage was identical to the rate of return of the RRSP, contributing to the RRSP would always deliver superior returns. Another reader even claimed that an investor would come out ahead by contributing to an RRSP if the annual return was just half of the interest rate on the mortgage.

Sadly, it doesn't work that way. For the RRSP to win over paying down the mortgage – assuming a constant marginal tax rate – the RRSP would have to deliver a higher rate of return than the interest rate on the mortgage.

I'm not saying that paying down the mortgage will always be the better option, or that people who contribute to RRSPs are making a mistake. Everyone's circumstances are different, and there are a lot of moving parts here, including future market returns, potential changes in marginal tax rates, and an investor's appetite for carrying debt and taking risk.

What I am saying is that if you want the highest guaranteed return available – emphasis on the word guaranteed – you can't beat paying off your mortgage. That's because, for every dollar of debt you eliminate, you effectively earn a rate of return equal to the interest rate on your loan. And, because banks charge more to lend money than they pay to borrow it, you usually can't find a guaranteed investment that pays more than the interest rate on a fixed mortgage of the same term.

The argument for paying down debt is even stronger for someone with credit card balances or other high-interest loans.

Before we get into some numbers, here's a question: Do you believe in borrowing to invest?

If you have a mortgage and you make an RRSP contribution, in a way you're already borrowing to invest. That's because your mortgage debt is effectively financing your RRSP contribution. If you don't believe in borrowing to invest, then you should consider making it a priority to pay off your mortgage.

You won't hear this kind of advice from a lot of financial advisers because there is nothing in it for them. If you focus on paying off your mortgage, they'll have fewer assets to manage, and they'll make less money. Granted, many advisers also sincerely believe that investing the money in stocks is a better long-term strategy.

What about the tax refund? Isn't that an advantage of contributing to an RRSP? Not necessarily, because the refund is really just the present value of what you'll owe in tax when you collapse the RRSP. Assuming a constant tax rate, the refund is a red herring. (For more on this, see my column at and read CIBC tax expert Jamie Golombek's excellent take, Blinded by the Refund, at

"Generally speaking, if you don't think you can beat your [mortgage]interest rate in your RRSP, then I think for most people the safest bet is to pay down the mortgage," Mr. Golombek says.

Here's a simple example:

Assume you have a $100,000 fixed-rate, 3.5-per-cent mortgage with a five-year term and a 25-year amortization period. We'll also assume that a five-year GIC is paying 2.75 per cent.

Say you just found $20,000 under your mattress, and you're wondering if you should pay down the mortgage or invest it in a GIC inside your RRSP.

Scenario #1: Pay down the mortgage

The $20,000 lump-sum payment immediately drops your loan balance to $80,000. After five years – 60 monthly payments of about $499 – your mortgage would shrink to $62,608.

Scenario #2: Contribute to an RRSP

Without that initial lump-sum payment, your mortgage would be $86,279 after five years. The $20,000 in your RRSP, meanwhile, would have grown to about $22,927. Result: You would have a net debt of $63,352 – $86,279 minus $22,927. (I'm ignoring the tax on RRSP withdrawals because I also ignored the tax refund.)

So, by paying down your mortgage, you would be ahead by $744. Paying the mortgage wins here because the guaranteed rate of return is higher. You might do better in the stock market – or, you might not.

But if you pay off your mortgage, you'll get a guaranteed return and the freedom – both financial and emotional – will last a lifetime. And the stock market will still be there after you toss your mortgage papers into the fireplace.

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