Peter Boys, Boys Financial Services

Debt Is a Low Priority

Drowning Piggy

For many Canadians, debt is a low priority and tends to viewed simply as monthly payments. Interest rates have been low for so long they don’t realize what will happen when rates start rising.  Many are either too young or have forgotten the 19% rates in the 80’s, where the majority of people’s payments went to pay interest on their debt.

Working Canadians may be able to absorb a 50% increase to their mortgage payments but it could dramatically impact their lifestyles.  And retirees to be burdened with even more debt.

In most cases people should pay down debt as quickly as possible, especially before retiring.  Going into retirement with debt is like playing Russian Roulette, as market fluctuations and other variables can have a big impact on income.  Interest rate increases could force seniors to withdraw more money to pay it off, which could push them into higher tax brackets and result in OAS or other benefits being clawed back.

Where homes represent a large part of people’s assets, a lot more growth is needed from their investments to pay off these big mortgages.  But entering retirement with high risk investments is bad planning.  Retirees with large pension plans and big debt can end up in a tax trap, as their income can push them into a higher tax bracket.  Plus, early retirement is not a good time to be withdrawing large amounts of income from your retirement nest egg.  If this looks imminent, they should consider a smaller home and liquidate that debt.

It makes little sense to own a big stock portfolio and still have a mortgage.  A better strategy might be to sell the stocks to pay off the mortgage, then borrow the money back using one’s home equity to repurchase the stocks.  Now the investment loan interest is tax-deductible.  This may not seem like a big deal when interest rates are low, but will make a lot of sense when rates do go up.

For those still in the saving phase but in a lower income and tax bracket, it may be best to pay off the mortgage before contributing to an RRSP.  On the other hand, those in the highest tax bracket may want to top up your RRSP first for the 39% tax savings.  Then use the refund to pay down the mortgage.

Maximizing RRSPs and putting every spare dollar into our mortgages is the ideal scenario, but in practice we’re not that disciplined.  As your home is already a tax-free investment option, paying down your mortgage might be better than saving in non-registered or TFSA plans.  If cash is needed for something such as a home renovation, a line of credit against your house may provide that.  However, for the less disciplined, there is the risk of it being used for lifestyle expenses.

Rather than making lump-sum payments, it’s better to contribute monthly into your RRSP or TFSA savings plans, along with your mortgage.  Some people have good intentions to make deposits into their savings, but see the surplus money in their bank accounts and are tempted to spend it.  If there’s no surplus, they don’t miss it and can’t spend it.  So when your tax refund comes, you’re free to do what you want with it!

If you are overwhelmed with all the possibilities of how to invest or save your money, talk to an experienced investment advisor to help you sort out it all out.

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