A Twist On The RRSP vs. Mortgage Debate

It’s an age-old financial dilemma. Should you use your extra savings to pay down the mortgage or contribute to your RRSP? A simple answer is to compare the expected return from your investments to the interest rate on your mortgage.

In today’s low rate environment, where mortgage rates sit well below 3 percent, many assume their investments will easily come out ahead. If rates tick higher, the mortgage pay down starts to make more sense.

RRSP vs. Mortgage

But there’s another factor to consider in the RRSP vs. mortgage debate, and it has to do with emergency savings.

What happens if the main breadwinner in the family loses his or her job? Who is more secure: the family that has $100,000 saved inside their RRSP, or the family that has a smaller mortgage but no savings?

Sinking all your free cash flow into the mortgage in hopes to pay it off early can leave you in a tight spot should you become unemployed for a long period of time.

And while you can reduce your payments back to the minimum, and even take a mortgage vacation for a few months, your bank still wants its money back.

A healthy RRSP balance, on the other hand, can help you weather the storm in the event of a long-term income drought. Sure, you’ll pay tax on any withdrawals from your RRSP, but that beats going into debt or losing your home.

An example

Let’s say a family bought a home worth $400,000 and used all their savings – $80,000 – for a down payment. They’ve diligently paid down the mortgage, doubling their monthly payments and adding a $5,000 lump sum each year.

After five years they’ve paid off $165,000 of the principal and owe just $155,000 on the house. They’ll be completely mortgage free in another four years.

This family prioritizes their mortgage at the expense of saving for retirement, thinking that once the mortgage is paid off they’ll start putting money into RRSPs.

He works full-time as a sales manager and she stays home with their two kids, ages 5 and 2.

When he loses his job, the family has no emergency income buffer to see them through the difficult times. After a month, he goes to the bank to apply for a line of credit, but the bank needs his recent employment history and pay stubs from the last two months in order to set it up. Sadly, the bank turns down his loan application.

Even though this family has nearly $250,000 in home equity, there’s nothing they can do to unlock the funds, short of selling the house.

Let’s go back to when the family first bought their home. This time, instead of putting every last dime into their mortgage, they add just $250 per month to their $1,500 minimum mortgage payment. This approach frees-up $20,000 per year to invest in their RRSP.

After five years they have over $112,000 saved in their RRSPs and they’re still on track to pay off their mortgage in a reasonable 20-year time frame.

When he gets laid off from his job, he’s able to draw from his substantial RRSP portfolio instead of turning to debt or being forced to sell the house.

The family has expenses of just under $5,000 per month, and the job hunt lasts five months. They need to withdraw $24,500 to pay the bills and put food on the table.

When you withdraw more than $15,000 from your RRSP the bank holds back 30 percent to pay the government on your behalf (withholding tax). That means the family has to withdraw $35,000 from their RRSP to end up with the $24,500 needed to cover their expenses.

Final thoughts

Even though it might feel like paying off your mortgage as quickly as possible is the most prudent thing to do, it can actually be a riskier move than investing in your RRSP.

In the second scenario, the family ends up back on their feet in a few months and still has nearly $80,000 saved in RRSPs. They continue to make their mortgage payments and won’t be forced to sell their house to get at the equity.

If you still can’t decide whether to prioritize your RRSP or mortgage, you can always go with the tried-and-true Canadian approach of making an RRSP contribution and then using the refund to pay down your mortgage.

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  1. Matt on September 9, 2016 at 3:50 am

    In the case of the people with $250,000 of equity in their home, what would the ramifications be of re-mortgaging the house to unlock the equity?

    • Todd on September 9, 2016 at 5:28 am

      They would still have to show the ability to debt service the (higher) mortgage payment based on employment income. Refinancing a home when unemployed (or retired, BTW) not generally doable.

      • fbgcai on September 9, 2016 at 7:14 am

        and that’s why, when you do your planning you set up HELOC / LOC when the sun is shining (i.e. you have income to cover) – once they are in place there is no problem drawing from the lines should the income have a blip

  2. JohnnyStash on September 9, 2016 at 6:09 am

    To me it all depends on what helps you sleep at night. Each family is different, do they have a pension, DB or DC…

    I think the message here is to advise the homeowner to negotiate the largest credit line with the bank when times are good and use it for emergency only.

    For me, mortgage free and the freedom that comes with it is the main priority. Our house will be paid off within 12 yrs of the original purchase date. Mind you, I have a DB pension plan and still contribute to RRSPs each year. We have a 6 month emergency fund and a $75k LOC which never has been touched (established from great advice of a widow who lost her primary bread winning husband and had to weather the storm without an LOC)

  3. Karl on September 9, 2016 at 6:39 am

    The housing market, much like stocks, won’t/can’t keep going up forever. My, and most other people that are around my age have parents that have went through 30+ years of declining interest rates. My dad still tells me about how stressed he was getting first mortgage at 18% 35 years ago and it was only for $38,000. They have been able to watch their property value grow to over 375K now. The problem is unless they severely downsize they will pay at least that much or more for their next place. My parents live in a town of less than 40,000 people in SW Ontario.

    Once I started working after college they “strongly” advised me to buy a property after my student loans were paid off. “You can’t lose buying a home” and “Why pay someone else’s mortgage?” was what I heard from them. Following their advice, I’m a current a home (condo, short term. 3-5 year outlook on moving to a fully detached house) and rental property owner. My parents advice has definitely paid dividends so far but I have come to realize that I won’t have the same luxury of 30 years of lowering interest rates (low possibly but not lowering) I am seriously considering selling my real estate and renting a reasonable home when my mortgages come due next year. Although I highly doubt I will be able to talk my wife into it.

    Obviously this is all relative to which housing market you are looking at buying in and what end of the market you are going for. 400k is top end where I grew up, but more 400-500K+ homes are being built there every day. A first time home buyer buying a top end home now in any market could very well be a losing/stagnant investment over the next 10+ years. The only option I see for them that works is buying a place you are comfortable staying in for the long haul. Which isn’t what I see most first time home buyers doing.

    What’s wrong with renting and funneling that mortgage money into their RRSP &TFSA. And once interest rates do go up, which I can only assume will drive housing prices down in most markets possibly even suburbs of bigger areas like Calgary, Toronto, Vancouver to a more affordable level for most first time home buyers, then jump in with a 20% down payment from your RRSP and whatever you have saved in your TFSA.

    B&E, Where do the two of you see things in real estate going? I would really love to see an article from you on this very topic. Love your articles guys, always very informative. KDH

  4. Carlos Henao on September 9, 2016 at 7:23 am

    If my clients want to prioritize paying down the mortgage, this is what I tell them:

    First off, don’t increase your monthly payments. If you are paying that mortgage off right away, then your money is tied up to your property.

    Instead, put some money aside into a separate bank account each month. Keep putting that money in, at the beginning of the month, because we all know that if you wait until the end of the month and put away whatever you have leftover, you won’t have anything leftover.

    AT THE END OF THE YEAR, you do two things.

    (1) First thing is make sure you have enough in an emergency fund just in case. Hopefully you already have enough for that in a separate bank account!

    (2) Afterwards, you make a lump sum payment towards your mortgage.

    Then, rinse and repeat. Start putting money away each month for your lump sum at the end of the year.

    Using this approach, if there IS an emergency partway through the year, you have the money to cover that. Not only do you have your emergency funds, but you also have the money you have been putting aside each month.

    Hopefully there won’t be any sort of emergencies, but you’ll be able to sleep well knowing there’s a Plan B.

  5. Cashinstinct on September 9, 2016 at 7:46 am

    I don’t see why RRSP are discussed here.
    What about TFSA? You gain back contribution room next year of withdrawal and have no taxes on withdrawal.

    The advantage of RRSP withdrawal is only if you:
    – have a lot of unused contribution room and see no way you can ever use it
    – have a really bad year and will have low fiscal income for the year (so you don’t end up paying much taxes on your withdrawal and get some money back after you do your tax return).

    • Carlos Henao on September 9, 2016 at 8:32 am

      I prefer TFSA’s. But if you can plan it out, RRSP’s might work out for you. For example, for someone who is just starting their own business, and they know they are going to have a low income year, they could withdraw some of their RRSP’s that year at a low tax rate.

  6. May on September 9, 2016 at 8:28 am

    Yes. If there’s one thing you can count on, it’s that banks will only loan you money when you don’t need it! The time to set up LOCS and overdrafts is when you are flush with money. If you wait until you need the help, you’ll get none. Been there, done that.

  7. Isitaneedorawant on September 9, 2016 at 12:01 pm

    We used our returns after fully funding RRSP’s to pay down mortgage.
    I cannot stress highly enough an emergency fund.
    Dave Ramsey suggests 3-6 month fund to cover ALL your household expenses.
    Statistically it is not a matter of “if” but rather “when” you will have a job loss.

    Retirement savings should not be halted to pay down a home.But they can be put temporarily on hold to aggressively pay down other forms of household debt that are your mortgage.
    What most people don’t realize is they should be looking at a percentage of their income to save for retirement(15% net is used by some fiancial writers).
    The percentage saved can be placed in your RRSP or TFSA. Retirement is not just about the numbers that you may be able to contribute in these plans. You might also think of retirement savings outside of TFSA and RRSP if you need to save that amount to equal your 15% net.

    A shorter mortgage amortization period 15 or 17 year can shave $$ off and still get you to the goal of mortgage free sooner.

  8. TJ Machado on September 9, 2016 at 2:54 pm

    For young families the HELOC is the best option. Flexible payments and cheap emergency funds. Maximize your RRSP and TFSA and send everything else towards paying down the HELOC.

  9. Wes on September 9, 2016 at 3:05 pm

    Robb, thanks for the great article which I will be sharing with my sons who just started on their own on the journey of owning mortgage debts. It will be a proof that this ‘Multi Level Investment’ thinking is not just my own idea. I had learnt about this idea from reading a book by a former financial guru, a Mr. Brian Costello and also statistical works by the late Paul Rockel on Mortgage payments Vs RRSP/TFSA savings. I followed their way of thinking and it helped me pay off my mortgage and build up my RRSP portfolio. Thanks again.

  10. Funny about Money on September 9, 2016 at 10:41 pm

    If I’d had to make mortgage payments at the time I was laid off my job, I would have lost my home. Fortunately, some years earlier I’d bucked my financial manager’s advice and used an inheritance and a ghost-writing fee to pay off the loan. The recession so trashed my savings that I couldn’t draw down from my CD and 403(b) but had to live on adjunct teaching income — less than minimum wage — plus Social Security reduced because I had to take it early. There was no way in u-no-where that I could have covered a mortgage and put any food at all on the table on that income.

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