Consider your RRSP, or mortgage?

Deborah Leahy

March, 2011

Canadians have some impressive financial goals for 2010.

Consider the following, taken from a poll conducted on behalf of Edward Jones in Canada: 48 per cent plan to pay down debt; of this group, 13 per cent want to pay down their mortgage faster. Twenty per cent plan to increase their contributions to an investment account, with 10 per cent saying they will contribute more to their registered retirement savings plan.

Paying down your mortgage and saving for retirement are worthy goals. But can you work toward them at the same time? Let’s consider the pros and cons of making larger-than-necessary mortgage payments. First, the “pro” side:

You’ll pay less in interest over the long term. Over the course of a few decades, the interest you pay on your mortgage could equal, or exceed, the mortgage amount itself. The sooner you pay off your mortgage, the less you’ll pay in interest.

You’ll realize more equity when you sell your home. The less you owe on your house, the greater the equity in your pocket when you sell it.

You could get a psychological benefit. If you can pay off your mortgage, you may feel as though a burden has been lifted.

Now, let’s examine the “cons” of paying down your mortgage early:

You might sacrifice investment returns. If you paid off a fixed-rate mortgage of five per cent, you are essentially “earning” a five-per-cent return. But if you could find an investment—such as the securities held inside your RRSP—that earned more than five per, you might be better off putting your money there. Of course, there’s no guarantee on the earnings you’ll get from your RRSP, but your returns will, in effect, be boosted by the RRSP’s tax-deferred environment. Furthermore, you get an immediate tax break on your annual contributions.

You’ll tie up cash in an illiquid investment. If your employment should be threatened or you face some large, unexpected expenses, you may need quick access to a large amount of cash—and it’s harder to get money out of your home than it is from your savings and investments.

You’ll risk being under-diversified. If you put all your money in your house, and the housing market slumps, your net worth might suffer more than if you had spread your money among a variety of assets, such as stocks, bonds and mutual funds. While diversification, by itself, cannot guarantee a profit or protect against loss, it can help reduce the effects of volatility. Clearly, paying down your mortgage early offers some significant benefits, but it could also incur some significant costs, particularly in the area of saving for retirement. And since you could be retired for two or three decades, you might want to take full advantage of your RRSP, your tax-free savings account (TFSA) and other retirement savings vehicles.

Ultimately, the mortgage-vs.-retirement question is a highly personal one and does not lend itself to easy solutions. But it’s not necessarily an either/or situation. You could, for example, increase your RRSP contribution and use your tax refund to make an extra mortgage payment each year. It’s your choice - so make it a good one.

Deborah Leahy is an investment adviser with Edward Jones, specializing in assisting seniors.