Pay off the mortgage or invest in an RRSP?

By Romana King on February 14, 2013
Estimated reading time: 4 minutes

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

Ask 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.