According to my professional entourage, more and more people are wondering whether it is better to pay off their mortgage or contribute to their RRSP. To a fellow financial planner who asked me what I would answer to this age-old question, I confess that I offered a lively answer that took her by surprise. I have to admit, this question really irritates me in spite of myself. The reason is simple: it’s not a good question. In all honesty, it is even rather a false dilemma.
Of course, I fully understand the motivation for this question. Interest rates being very high, it is true that the same mortgage payment, if your loan is at a variable rate, does not make it possible to repay as much capital on your initial loan as before. For those who are renewing their loan, it is also true that the new monthly payments negotiated will eat up a new part of the disposable income.
At the same time, we recently received our investment statements as of December 31, 2022, confirming a disastrous year for a majority. The first observation is therefore that in the short term, the cost of borrowing is higher than the return on your investments, which is in stark contrast to the portrait of the last decade. However, I will not devote this column to presenting a comparative analysis showing the increase in projected net worth according to different scenarios between one or the other of the options. The real question is quite different.
Challenge discretionary spending
The most useful questions are sometimes the most painful. Should I put off that annual trip down south, the new mountain bike, the change of car to pay off my mortgage faster? Should I revise the budget for outings, leisure, restaurants to repay my mortgage faster? Yes, these are the right questions to ask. The current context calls for cautious optimism, which I regularly recommend to my clients.
The real issue here is in discretionary spending, those associated with pleasure. In most cases, these are the expenses that should be questioned if you really want to improve your financial situation. Not your retirement investments like an RRSP.
Very simple, in theory, this basic principle is very difficult to put into practice. Your budget should be adapted according to your new mortgage commitments and your other loans, as well as the increase in your fixed expenses. This exercise should include savings in basic expenses.
The last step will be to review your discretionary spending, with all the heartbreak and disappointment that may ensue. The key to the success of this approach could well be to be accompanied in the implementation of a long-term financial plan. By visualizing the concrete impacts of savings in the preparation of your financial independence, you will undoubtedly increase your motivation.
So no fun as long as I have a mortgage left? you will ask.
I can already hear my brother, the bursar, seizing the opportunity: “So you’re telling me that I can’t travel as long as I have a mortgage? No, that’s not what I say as a balance ambassador.
An Ipsos survey conducted online among 2,001 Canadians between December 8 and 16, 2022 on behalf of TD Canada Trust told us this week that only 59% of them would have invested in 2022. This demonstrates, on the one hand, the population’s insecurity in the current economic environment and confirms the importance of being surrounded by experts to make informed financial decisions. However, it may well be that these results illustrate that the majority of households have chosen, in response to the rise in interest rates and the cost of living, to reduce savings before reviewing their personal spending. Like what it seems natural for the human being to wait to be “with the foot of the wall” to bring important changes to his habits.
What I’m saying, then, is not that you have to eliminate all budget items associated with pleasure in order to pay off your mortgage faster. However, a reprioritization exercise should be initiated if your first instinct is to stop investing in your RRSPs in response to the new financial reality. RRSP contributions not only make it possible to save for retirement, but they allow many households, even those with more modest incomes, to increase their liquidity in the short term by generating, of course, a tax refund, but also by optimizing the effective marginal tax rate, which allows the increase of many socio-fiscal benefits.
So, RRSP or mortgage? I answer: wrong question! You should ideally do both, period. Since we have to see the positive in everything, let us be grateful if we are among the households having the possibility of adapting their financial strategies rather than experiencing the financial insecurity brought, for others, by the context of current inflation.