Q: I am getting a small windfall soon. The money would pay off the rest of my mortgage which is just under 3%. It would also be enough to pay off my credit card debt, leaving a couple thousand to buy American dollars for my travel account. Should I play it safe and do the above or should I be opening up a TFSA account and contributing also to my RRSPs? Or should I be looking at purchasing a rental condo? I am 52 and my wife and I have both good jobs.
A: I think that one of the best things you can do with a sudden windfall, Ed, is nothing. People often feel compelled to act right away. Or they are made to feel that way by financial advisors who have something to gain. Take your time and evaluate your options.
I think paying off your credit card debt is an easy one. I’d do that for sure.
Beyond that, the decision to pay down your mortgage is a tough one. You have a low-rate mortgage that may be even lower now given the rate cut last week by the Bank of Canada–if you have a variable rate mortgage. I wouldn’t be surprised if there are further rate cuts in the coming year as the impact of lower oil prices and slower growth in China ripple through the Canadian economy. And even if rates don’t go down, I think we’ll be in a low rate environment for the medium term here in Canada with rising rates likely happening at a slow pace.
So the low rate on your mortgage makes it compelling to consider investing the excess. Whether or not you do so depends on a number of factors, Ed, that are personal to you and your wife.
Are you guys conservative investors? If so, you might be hard-pressed to earn more than the 2-3% you’re paying on your mortgage given current GIC and bond yields. If that’s the case, pay down your mortgage.
Are you guys on pace to be mortgage-free by your ideal retirement date, even without using this windfall to pay down your debt? If you’re not, I’d be more inclined to use at least some of the windfall to pay down your mortgage and accelerate your debt-free day.
If you have RRSP room, high tax rates (you mention “good jobs”), modest to high risk tolerance and a reasonable comfort level with investing, I’d consider using some of the windfall to top up your RRSPs. You might not want to put it all into your RRSPs right away, or if you do, you may want to take your tax deductions over a couple of years. This is so that you don’t take a big tax deduction and bring your incomes and tax down really low in one year, when you could have got a bigger tax refund taking the deduction over a couple of years at a higher tax rate.
I’d probably opt for RRSP contributions over TFSA contributions if your incomes and tax rates are high and TFSA contributions may then be secondary.
If you have kids and may be contributing to their education, consider RESP contributions over TFSA contributions if you haven’t already maxed out.
If you decide to purchase a rental condo, I’d probably not use the windfall towards the purchase. If you did, you’d still have your home mortgage and the interest on it would not be tax deductible. Since the mortgage on a rental property would be tax deductible, I’d be more inclined to pay down your home mortgage and take out a larger mortgage on the rental condo to ensure you have the maximum tax-deductible debt you can.
Rental real estate, in my opinion, can provide comparable returns to a balanced investment portfolio.
In summary, Ed, what you do kind of depends on you. What’s right for you and the Mrs. may not be right for someone else. But start with the credit card debt and then evaluate your other options based on risk tolerance primarily. No matter what you do, it sounds like the result will be an acceleration of your financial independence.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.