Yahoo Finance FP Answers: Is paying down my mortgage or investing in RESPs the better choice?
By Julie Cazzin with Doug Robinson
Q: My husband, Robert, and I, both in our early 40s, bought a house in Toronto four years ago. We have a variable-rate mortgage and have been making biweekly payments. Our mortgage rate has gone up twice and is now at 3.8 per cent. We have managed to make $120,000 in extra payments on the mortgage and have $180,000 remaining. My husband would like to stop the extra payments and use the money in a registered education savings plan (RESP) for his son, who is headed to university in four years. I think the money is better spent on paying down the mortgage, which at our current rate would be fully paid off in six years. That would free up lots of cash flow to assist with university as well as obtain a home equity line of credit (HELOC) if necessary. What are your thoughts? — Amna, Windsor, Ont.
FP Answers: Amna, paying off debt is a good thing to set as a family goal. The worst debt is high-interest-rate debt such as credit cards. This debt should always be paid off in full. The best debt is low-interest-rate debt, in which the interest is tax deductible because the debt has been incurred to earn a greater income from the asset it has been used to purchase. A common example of this is a rental property or an income-producing investment portfolio.
The debt you have is non-deductible since it has been incurred to purchase your principal residence, but the interest rate is still reasonably low at 3.8 per cent. The recent increase in interest rates will have pushed your mortgage rate up again.
You ask if it is better to make extra payments to an RESP for a child going to university in four years, or to keep making extra payments on the mortgage. The answer is that you should divert payments to the RESP immediately.
I am assuming you have not already received the maximum lifetime grant of $7,200 from the government for this child. But either way, investing in an RESP will earn the rate of return of the investments you purchase in the plan. If you purchase an aggressive investment portfolio, you should expect to earn more than five per cent on your money over long periods of time, so that’s better than having debt that you are paying less than five per cent on.
However, you don’t have a long-term time horizon and knowing you are debt averse, I expect you will have a more moderate risk tolerance. Right now, you can buy a four-year guaranteed income certificate (GIC) with a return of about 4.5 per cent.
Let’s assume you did this and are locked in for the next four years while the interest rate on your mortgage keeps rising to more than 4.5 per cent. Normally, this would be the case in which paying down your debt would start to make more sense.
However, the government makes a matching contribution of 20 per cent of the amount you contribute to an RESP, up to $1,000 each year. Therefore, you should divert $5,000 toward an RESP before the end of each calendar year up to and including the year the child turns 17.
The combination of the grant and the investment gains on the RESP will exceed the interest you would be saving by making larger mortgage payments.
Over the years, I have frequently observed clients who work hard and pay off their mortgage, only to take out a new mortgage to pay for post-secondary education. They missed out on all the RESP grants the government would have provided, which is not optimal. I encourage you to maximize the grants your child is eligible to receive.
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The grants and the investment growth are both taxable to the post-secondary school student in the year of withdrawal. A student who is employed can earn about $16,000 without paying any income taxes. The principal you contribute can be paid back to you tax free.
In general, whenever you can make an investment with an expected return greater than the interest rate on the debts you are paying, it is advisable to do so.
I would take it a step further to suggest that even if the investment provided a moderately lower return, a family should be sure to save some money so they have a cash reserve in case of emergencies. The size of this reserve depends on your spending, income and personal comfort. Keep this in mind when making your final decision.
Doug Robinson is a certified financial planner and wealth adviser with Veritable Wealth Advisory in Peterborough, Ont., a full-service financial planning and investment firm that employs multiple CFPs and portfolio managers with offices in Burlington, Kingston and Peterborough.
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