Free Money

There has been a long term debate of whether people are better off paying down their mortgage or contributing to RRSPs. Due to the variables of tax brackets and the return on the RRSPs there are no clear cut answers. Most of the time the opinion given is do both, contribute to your RRSP and use your tax refund in the spring to pay down your mortgage. This “meet in the middle” approach is good but can be optimized to give you some free money and have you debt free a little sooner.

Most people are aware that if you contribute to an RRSP you should see a tax refund in the spring.   The bad news is the C.C.R.A. has held onto your money for the whole year and then given it back to you without interest. The math does not work out in your favour. The good news is it doesn’t have to be that way.

You can go to your Human Resources department and ask to fill out form T1213 Request to Reduce Tax Deductions at Source. For example let’s say that you are contributing $600 per month to an RRSP and every spring you get a tax refund of $2,400 as a direct result of your monthly RRSP contributions. That refund is great, but the C.C.R.A. has owed you a little bit of that money every month. Once you fill out the form you will now see an extra $200 monthly on your pay cheque . Unfortunately you will not get a refund in the spring.  The C.C.R.A. will take your monthly RRSP contribution into account and tax you less.  You have your money now!  What good does this do you?  Well, now instead of a $2,400 lump sum mortgage payment in the spring you can increase your monthly payments by $200.  It makes a big difference.

A $250,000 mortgage at 6% with monthly payments of $1,487 has an original amortization period of 30 years. Add the $2,400 prepayment every spring and you save $81,634 in interest costs and your house is paid for in 22.5 years. Not a bad deal at all.

If you don’t make a $2,400 prepayment every spring and instead increase your monthly payment by $200 you will save $84,620 in interest and have your house paid for in 22.33 years. For about an hour of your time you have saved just under $3,000.

I believe that the little things make the difference and this little rearrangement of your finances will help you pay off your mortgage faster, save you money, and help you be debt free faster!