Pay off the mortgage or invest in an RRSP?

Low interest rates and returns are prompting one of the longest running debates in personal finance

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house_money_seesaw_1008_322Ask three experts whether you should pay down your mortgage or invest in your retirement and you’ll end up with at least four different answers. That’s because over the years experts have consistently disagreed on what the best strategy is for your financial well being. And these days it’s a particularly hard question to answer.

With the average discounted mortgage rate hovering around 2.7%, you’d think prioritizing your RRSPs over your mortgage was a no brainer, right?

Not necessarily. If the historical rate of return of 10% applied to today’s market then the dilemma would be solved. But five years ago everything changed. Now, planners are suggesting that the best possible return for a well diversified, balanced portfolio (typically 60% equities and 40% fixed income) is 6% before inflation. That’s 4% after inflation. What’s more, planners believe that this return won’t change much for the next 10 or so years.

Despite all this ambiguity you can still figure out what’s best when it comes to the mortgage vs. RRSP debate by answering three simple questions:

1) How disciplined are you?

I’m not talking about whether you can resist the last cookie in the package, or stop yourself from going for seconds at the buffet. The real question is whether you are disciplined saver.

If, for instance, you paid off your student loans and then used that surplus of cash to invest in your retirement, or to save for a down payment on a home, then you, my friend, are a disciplined saver. You would benefit from paying off your mortgage first.

If, however, you bought a car and went on a vacation once you had a bit of extra cash then paying off your mortgage—a non-deductible debt—would not be prudent.

2) Are you a nervous Nellie?

Ask yourself: what keeps me up at night? And be honest. If it’s the idea of debt, then pay down your mortgage first. If you lose sleep at the thought of poverty in your golden years, then contribute to your RRSP first.

3) Have you done your math?

Just before his book, “Financial Freedom Without Sacrifice,” was released, I spoke to financial author and educator Talbot Stevens. According to Stevens the math behind this age-old question is quite simple:

If your interest rate on your mortgage debt is 3% higher than the average annual return from your retirement portfolio then ignore your RRSP and pay down your debts.

Keep in mind, though, that the average annual rate of return for a balanced portfolio is 4% after inflation—that’s only a percentage point and a bit more than most mortgage rates these days.

Still, Stevens suggests that every investor should prioritize their debts. Pay off high-interest rate credit cards first, then move to loans and lines of credit, then your lower-interest rate mortgage.

By answering these three questions you can quickly determine whether paying off your mortgage is the right move for you, or if you should be investing in your retirement fund. If you’re still in doubt try a mortgage vs. RRSP calculator such as this one by Empire Life or the province-specific TaxTips.ca calculator, or the Growth Works calculator that lets you add extra inputs.

7 comments on “Pay off the mortgage or invest in an RRSP?

  1. I think it's pretty simple really. Why would you throw money into a depreciating asset with mortgage interest rates so low. A well diversified portfolio with good exposure to Ameican and other foreign equities is going to clearly outperform paying off your mortgage.

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  2. We had this question to ask ourselves even though we do contribute to our RRSP's and TFSA each month. We decided to pay the mortgage in full in 2013 which leaves us over 30 years to plug away at the RRSP.

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  3. Loved the point of a nervous nellie! RRSP's with a 10% return look mega appealing!

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  4. A lot of the comments assume a rate of return on investments is a sure thing. I have had RSP money in Mutual Funds through Sun Life and Great West Life (who took over funds from Fidelity). Over the last 5 years the overall rate of return is NEGATIVE. I would have been better putting the money under my mattress. The only "return" was the original tax credit. The interest savings (in after tax dollars) from paying down the mortgage principal IS a sure thing. Despite what the financial managers, brokers and mutual fund companies (who have their fees as a sure thing) would like you to believe, the stock market is not a sure thing. What is the average rate of return in mutual funds (with people whose job it is to pick stocks doing the picking) over the past 5 years? Of the funds available in my Sun Life plan about half have a 5 year rate of return. The others haven't been around long enough I guess. The average 5 year return of the 48 mutual funds with a 5 year return is 3.3%. That's total over 5 years! Pathetic. Switching to a self-directed RSP and ETFs.

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  5. Consulting about different lenders is a good idea. However, self computation is a better one if you just know how. In this manner, you will be able to determine what option best fits for you.

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  6. Yes, but the way I see it is; if I have $10K and my tax bracket is 33% at the end of the year I get $3.3K just by investing on my RRSP rather than putting those $10K on my mortgage; now for “the investing part”, if the mortgage rate is 2.7% as your article states, investing rates (funds) will always be higher, even at 4% it becomes 1.3% more, plus instead of just “investing” $10K in your mortgage, now you “invest” 13.3K on a 4% rate.
    Obviously you can’t predict that the mortgage rate won’t increase to 8-10% as they were before, in which case you are extremely exposed but to me the RRSP investment works best as I am 1) In a high tax bracket, 2) My mortgage is only 10 years to go (with a lock mortgage for 5 years), even if the following 5 years are horrendous and the mortgage rate goes to 8% (which I dont see happening), I can always sell the house and downsize (retirement is in 10 years) and I can always rent.
    Hence it always depends on your personal situation, your tax bracket and how much are you still owing on your mortgage.

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