RRSPs: Save for a home and eliminate debt

By Bruce Sellery on November 23, 2012
Estimated reading time: 5 minutes

Have your cake and eat it too. Pay off your debt while socking away cash in an RRSP to make your home ownership dreams come true, says Bruce Sellery.

Question

I just graduated from university and I am now making $100,000 in my first job. I am thinking about buying a property, but I am currently paying off a lot of debt: $21,000 on a line of credit at 4.5%, $33,000 from student loans at 5.5%, and a car loan of $8,000 at 3%. I am currently making aggressive payments of $1,000 per month towards each one. Should I pay off my debt first before I start saving for a down payment? I am afraid property values are going to spike if I don’t buy soon. What’s my best option?

Answer

Congratulations on landing such a well paying job. No doubt you worked very hard for many years to get it, and now you can use that income to build a solid foundation for your future. You’re thinking about the right questions, with one glaring omission: RRSPs. You didn’t mention contributing to retirement savings and that is a big miss. I know you’re just coming out of school and retirement seems like an eternity away, but there is a compelling case to be made for starting now.

Take advantage of RRSPs

Contributing to a registered retirement savings plan will allow you to defer tax into the future. That’s an important consideration for you, especially since your salary puts you into a high tax bracket. By putting money into your RRSP you’ll generate a bigger tax refund, which you can apply towards debt reduction. The other big benefit to this approach is that you can use your RRSP nest egg to help you buy your first home. It is called the RRSP Home Buyers’ Plan and it allows you to withdraw money from your RRSP to use towards a down payment. You will have to pay the money back, but you’ll have 15 years to do it. In financial terms the HBP is a close as it comes to having your cake and eating it too.

Eliminate debt before saving

As for saving for a down payment outside of your RRSP, I wouldn’t put it high on my list. Pay your debts off first. Here’s why: Getting rid of your student loans, for example, eliminates that 5.5% interest payment. It would be very hard for you to generate an after tax return that exceeds that amount, what with savings accounts earning less than 2% these days. The most efficient thing to do is to pay only the minimum on your car loan, because the interest rate is so low. Focus on the debt with the highest interest rate first, in your case your student loans, and work your way down from there.

Avoid real estate frenzy

I also don’t think that you should rush into real estate. Sure, owning a house has provided a phenomenal return over the past 10 years, at least for those people who bought in major markets like Vancouver, Calgary and Toronto. But there is no guarantee prices will continue to rise at such a clip. Interest rates will go up at some point and that will temper demand in the housing market. And even if you were able to save $1,000 per month, it would take you two years to save $24,000, which is a 5% down payment on a $500,000 home. Buying a home at your age also adds a lot of additional costs: property taxes, maintenance, plus expensive upgrades to make it feel like home. Your better bet is to live more simply and continue to sock your money into RRSPs and save for a bigger down payment once your debt is done. It’s also worth noting that if you can only save a down payment of 5% you’ll pay about $14,000 more for mortgage loan insurance. Ouch. All in all, don’t worry about a price spike. Instead focus on building a solid financial foundation.

Watch out for lifestyle inflation

There is one last thing to keep in mind, now that you are earning such a juicy salary: lifestyle inflation. This is when you spend more with every pay increase and never really get ahead. You have a huge advantage given your high income to repay your debts quickly, if you can keep your expenses low.