Debt, house morgage or RSP?

[George W. Bush]

Ok, I have $140 000 to pay for the house (mortgage), and $25 000 credit line that needs to be paid. I talked to an investor and he suggested I invest $400 (or what I can) in RSP for 5 years. I will buy this $20 000 RSP at prime + 1.75%, and he told me that in 5 years I should have made about $28 000 on this $20 000 that I take for RSP.

Now I am a bit leary of investing money somewhere knowing that the $400 (if paid towards the mortgage) may have a greater effect that the $8 000 gained over this term of 5 years.

I am not too sure whether having to spend another $400 into RSP is the best choice now, knowing that I have mortgage and $25 000 LOC to get rid off. I was thinking that extra money put into the mortgage in the first 5 years will be much more beneficial.

What is your take on this?

[arnyk]

Determine your effective cost of borrowing (factor in any tax benefits) for the mortgage and the LOC.

Compare this to your expected after tax return on investing. Remember that anything greater than the risk-free rate is uncertain.

$8 000 over 5 years is approximately 7.00% CAGR. Assuming this is net of interest expenses, it is an unrealistic return. RSP loans are not tax deductable, and so your best case scenario would be Prime (6.00%). This implies a pre-tax ROR of 15.0%. Overall the long term (>20 years), equities have returned approx. 8%-12%. But let's say your friend is right, and you do get 7.00% pre-tax. Net of taxes this could become 5.00%.

Now is this rate of return greater or smaller than your cost of borrowing? Keep in mind that paying off your debt gives you a guaranteed return of that debt's interest rate, tax free (the the mortgage is at 7.50%, you get a risk free tax free return of 7.50% by paying it off). Also keep in mind that the 5.00% return on your RSP investment is not risk free - and 5 years is not a long enough time frame for 100% equities anyways, so your expected return would be much lower if you were to invest prudently given the time frame.

Now that all that's out of the way. You have to factor in the refund you will get by contributing to your RRSP. It may be a good idea to contribute, and use the refund towards your debt.

[George W. Bush]

LOL - some of what you said does make a little sense - most of this is beyong me! :) I personally would rather pay off the debt ASAP, and after the debt has been paid - at least the Line of Credit (LOC), then go and invest in RSP or something that is worthwhile.

I personally am not too eager to obtain $20 000 in RSP at prime (6%) right now - with the debt that I have. I personally think that the 400 spend a month in paying off the mortgage will pay off much higher than the potential $8000 or even the $15 000 that may be gained by investing in RSP over 5 years (but such revenue is unrealistic).

[vr6man25]

DOING A basic calculation
on a 25 year amor

$140000 5 year term @ 5.35% you pay
$35527.92 in interest, balance of $124694.31

now if you put $400 per month for 5 years(60 months) on mortgage
140000 5 years term @ 5.35 you pay
$ 32081.16 in interest, balance of $ 97247.55

you drop mortgage faster in the amount of $27446.76 in 5 years
also you save $ 3446.76 in interest TOTAL of $30893.52

now $400 x 60months = 24000
if you put it in rrsp 4800 per year if you are in a 30% tax bracket you get 1440 back
$1440 x5 =7200
24000+7200=31200
now who know what the markets could do and if you could double your money in 5 years or what. but if you do 5% average for 5 years that 24000 turns into $27241 roughly
I am still trying to decide what I will do , pay the debt down or invest, fine line for each, Its so hard to decide.

Sorry guys but i need some sleep , CORRECT me guys if i made mistakes
thanks.

[gman]

Pay down your high interest debt first. In your case, the LOC.

[dark169]

I assume your already making some sort of payment on the LoC, the intrest at least?

What I would do is put the 400/month into your RRSP's, dont consider the return on this money as you wont be using it for the next 20-30 years anyway. 400/month = 4800 /yr which roughly translates into 1440 in tax return. Use this tax return to pay down your debt a little faster.

One of the #1 rules of personal finical planning is to pay yourself first. If you spend the next 20 years tring to be debt free THEN start thinking about retirement you'll be in a whole heap of hurt.

Even if yuo dont put the whole 400/month into RRSPs but say do 300 into RRSP and 100 onto your LoC after 5 years you would have paid down 11400(100*12*5+(30%(300*12*5))) of your LoC and have 18k+gains for your retirment. And thats only with this $400.

[Justin C]

I would definitely start putting some money into RRSPs for the tax benefit. Do not take out an RRSP loan though. Just put $200-$300 per month into the RRSP (even something like ING Mutual Funds should work and they have no fees), and put the rest towards your line of credit. You should get about $1000 extra on your tax return each year.

If you have an RRSP plan at work that matches your contributions, then do that instead.

[slim_shady]

Just keep in mind that an RRSP is just a tax deferral, you will still pay taxes on it, just later (with the idea being your tax rate will be lower when you retire) instead of now.

That being said, the best overall tax strategy is to invest in your house as it is fully tax-free (assuming it's your principal residence). A benefit of this, if you are able to pay off your house fully now, it will give you much more disposable income (no more mortgage payment) which can then be used to invest in RRSP's.

Taxes aside, the wisest move is to first pay down any debt that has an interest rate above your realistic anticipated return from RRSP's (but you lose the compounding benefits, depending how long it takes you to pay down your debt).

[Bullseye]

If you're not a reasonably educated investor, then forget the RSP loan, too risky for you. Sounds like someone is trying to make more commision on you by getting you into investment loans, is this person selling to you?

I have an RSP loan, but I was reasonably sure (and have been proven right thus far) that I could beat the interest rate with my returns. If I can do that for the full term, the tax I got back is all bonus. Or at least deferred for 30-40 years!

[George W. Bush]

Very interesting ideas. Indeed, someone in the financial sector trying to get me into an RSP loan (at prime + 1.75% borrowing rate).

I rather put in an RSP - as you have kindly and wiselly suggested IMO - about $200/month and in parallel with that, pay off the LOC and the mortgage. I am very weary of getting another "LOAN" - I rather put this money into an RSP.

What about putting this $200/month into an unregistered investment instead of the RSP? We will still be taxed on RSP when it is taken out?

The thing is that we also have to remember that in say 20 years from now, when we take the money out of RSP, we will not be able to purchase much with it due to inflation. Think about it this way, today, what can you do with $20 000 vs. what you could have done with it in 1986? I am sure that $20 000 in the mid 80's could have gotten much further ahead...

My thinking is to get debt paid off ASAP, or at a constant rate vs. investing in the hope of who knows what. Yes, it helps, but it is not the magic bullet.

Ok... so what 649 numbers should I play tonight!? :)

[mart242]

Prime + 1.75% is quite high. Can you get a home equity line of credit instead? Or simple line of credit at a lower rate?

[Xtreme2001]

Pay off the loan first. Your return will be prime + whatever % = 7-7.5%. At least this way you KNOW what you'll be receiving, rather than hoping for investments to hit a high return of 8-12%/year to give you a gain. Keep in mind it may even be in the negatives!

Although the #1 rule of paying yourself first is a good point, I feel this strategy is only for those who don't have the mindset and drive to save properly. Forcing oneself to pay off debt is self-rewarding all together, similar to investing. I don't intend to step on any toes, it's just a thought.