Financial Question: Which Makes More Sense??

[drlove 37204]

Assuming you have the choice between the following, which is the better alternative?

 

After having taken out $25,000 of your RRSP (first time home buyer's plan) do you:

 

A) Set aside extra money to repay your RRSP withdrawal within 15 years so you don't get taxed

 

B) Forget about paying back the RRSP for the time being and focus on making yearly lump sum payments on the mortgage principal (as much as you can afford)

 

What do you think?

[etasman2000 15994]

What is the tax rate for (A) ?

 

What is the interest for (B) ?

[buggernot 588]

Yeah, there's a few other factors you have to take into consideration like length of mortgage, current term, do you see yourself in that same home 15 yrs from now, etc?

 

With the rates as low as they are now and the fact that the first half of your mortgage is where you're paying the majority of the interest, if you can slam as much extra cash on to your mortgage payments now, the end saving will be huge. If you don't have the $25K to pay off the govt when the time comes, redo your mortgage.

 

I'm no financial advisor though, nor do I own a house...so take all that with a grain of salt ;)

[TRman 536]

Well, here is the sitch (IMHO):

 

CRA requires you to pay back the RSP loan over 15 years. The first year is a grace period. Simply put, if the pay back amount was $1,800 per year and you did not designate the money it would be added as income. About $800 in taxes payable if in the top bracket.

 

Buying a house with a mortgage is simply a leveraged loan. If you put $25k down on a house for $250k and the market goes up 10%, you have a 100% tax free return. There is no taxation on a principal residence. With an RSP (which I do like, depending.....) the growth is taxable in the end upon withdrawl at 100%.

 

Years ago, maybe 25, a house could be purchased for $100k if you put $10 k down the mortgage was $90k. A very large amount at the time (trust me). If the principal was never paid down, the mortgage would still be $90k, and the house about $250k. Now a days that mortgage would seem small. Do the math on the real gain. $250k less original amount = $150 k. 10k down, = 1500%. Leverage can also be nasty so watch out. House prices are NOT a sure bet.

 

Essentially it comes down to emotion. People sleep better with less debt. Financially, the RSP is better especially if you use the tax return amounts to re-invest and not as a March break holiday.

 

I would wait and see how the mortgage rates go up over time and what your taxable income is if it changes from year to year. No decision required for 2 years, and even then is done on a yearly basis as each year is independant.

 

I could go on - blah blah blah...

[daddio 2704]

The first thing is that free advice is worth exactly what you pay for it.

 

The second thing is I think you've limited your choices.

 

Take into account the fact that none of us is immortal although we like to live life on the basis that we are, or at least close to it.

 

So, my advice is (and remember it's free):

 

Use your money to enjoy the company of many ladies on cerb!

 

You'll help us get out the recession.

 

What do you think ladies?

[hunknhot 1067]

Either way you will be forced to pay back a minimum to the HBP on your RRSP, but max out your mortgage payment.

Here are some ways to eliminate your mortgage in 10 years or less..

 

1- If you need to lock the rate in the first five years then do so but try to put more than just the normal amount each month.

 

2- The amount you pay each month doesn't change each month so increase the frequency.

eg $1000 month. change it to $250 /week as an example. Huge interets savings as more will go to the principle.

 

3- After the term is expired no matter what they offer your to re-sign (the mortgage people banks and brokers work on comission) convert it to a home equity line of credit (it's a low variable interest rate but you and not paying future interest)

 

4- Put the max down that you feel comforatble with each month. No need for the weekly at this stage since interest is calculated on the outstanding amount. Even if you maintain the same amount this is better than what you had before but work it out based on your needs.

 

5- Max out your RRSP but on pay only the min back in the HBP (home buyers plan). You will see the formula on the standard tax forms.

 

You will see the amount you owe drop very quickly over the years. I know not everyone can max out the way I described above but there are happy balances.. maybe you can eliminate you mortgage in 12 or 14 in stead of 25.

 

I am not a financial planner by trade but part of the family business is in real estate investments. I used the above methods and and I am a happy person. Most tax preparers will know how to manage the tax implications as the HBP is one of the most popular federal programs

 

There is also another option which is more complicated but you can do a "non-arms length mortgage" to yourself from your RRSP. In essence the investment you are buying is you. You loan yourself the money to buy a property. google it.. it requires some legal documents and a willing bank/trust company to administer the loan to yourself.

 

Basically all the interest you pay (short of the bank fee) gets paid back to you. Why pay the bank when you can pay yourself. No bank will ever tell you about this program so you need to research your bank. When you google it you will see a list of canadian banks that participate. It helps if you have a nice stash in your RRSP.

 

There are many other ways to do it but this are the easier ones.

 

pm me if you have any questions...

 

Now back to our wonderful ladies ;) and ladies invest wisely. Even with cash you can invest safely!

[hunknhot 1067]

Had to edit my post!.. I better proof my writing more after a long day!

[Guest s******ecan****]

there is no one "right answer" to this question and the example provided does not give enough information to produce a complete answer.

 

In regard to the earlier post which mentions that RRSP investments are taxed eventually but housing gains are not this can be misleading. While it true that if you sell your home down the road you won't be taxed on the gain itself (ie bought it for 100K sold for 250K = 150K gain that is non taxable) unless you're planning to buy another house, put those funds in a mattress or a hole in your back yard you're presumably going to invest it somewhere and guess what? Its going to start producing taxable income. If you don't sell your house then what will provide you with the income you will need at retirement? Houses can have many disadvantages as investments, they are somewhat illiquid, are extremely undiversified, tend to have high costs associated with selling them (though this is changing thankfully) can't be partially liquidated, etc.

Also there is no guarantee the tax exemption on capital gains on your principal residence will remain in place forever. As the baby boom generation ages and puts ever increasing demands on our health care system governments are likely to become more and more aggressive in finding new sources of revenue.

 

As in all things moderation is usually the key, a comprehensive plan tailored to your own situation is the best approach. That requires some real investment of time on your part with the assistance of a trained, trustworthy, and competent advisor.

[drlove 37204]

Thanks for your help, everyone! Much appreciated.

[cbbloke 100]

Here's another angle to consider. If you have a variable rate now, your aftertax cost on your mortgage is 2.25%. If in a high tax bracket, say near 50%, your real cost is 4.5%, meaning an alternative investment would need to earn 4.5% interest return, to equal what you are paying back to your lender.

 

With equity markets where they are now, I would suggest that you would do better putting your money into an equity investment such as stocks or mutual funds, and they will do better than 5%. When the TSX returns to 15,000 (not if, its when), the gain from current level is 3500 points, or 30% higher. If it's 3 years, that's probably 9% compounded. Almost twice the benefit. If they are in RRSPs compounding, no tax on the gains until you take them out.

 

These factors don't factor in declining principle on the mortgage for principle payments, just simple interest only calculations.

[Guest s******ecan****]

 

 

2- The amount you pay each month doesn't change each month so increase the frequency.

eg $1000 month. change it to $250 /week as an example. Huge interets savings as more will go to the principle.

 

 

 

3- After the term is expired no matter what they offer your to re-sign (the mortgage people banks and brokers work on comission) convert it to a home equity line of credit (it's a low variable interest rate but you and not paying future interest)

 

Point 2 will only provide significant savings if you choose accelerated payments with a more frequent term. Just changing the frequency alone provides only limited savings (ie you can't get something for nothing). Just changing the frequency (ie monthly to weekly) means your payment is in effect being made early, so some interest is saved. Its the least you can do so long as your cash flow allows you to make weekly payments. If your cash flow isn't certain don't do it, 1 NSF mtg payment is enough to wipe out the savings that month and then some as well as damaging your credit rating. Choosing to increase the frequency and "accelerate" the payment does result in big savings. What does accelerate mean? It means a higher annual payment towards your mortgage (remember you can't get something for nothing).

While some banks calculate it differently accelerated generally means you will be making 4 extra payments per year if you choose accelerated weekly, or 2 extra payments if you choose accelerated bi-weekly.

 

Point 3 is normally only an option if the you have built up at least 25% equity in your home prior to renewal (ie if your home is worth 100K the mtg at renewal must be 75K or less). As well interest rates on equity lines are not fixed and are usually higher than variable rate mortgages. In addition you'll have to be sure you have the discipline to pay down the equity line and not treat it like some jumbo credit card (which is what most people with equity lines do). Normally the bank only requires you to make the monthly interest charge (they're happy not to have you pay it down more interest for them next month) in which case you're getting no where. Still there may be months when you'll find it tempting to do just that. Or you may find yourself using it to buy cars, vacations, etc etc. As well it doesen't cost you anything to renew your mortgage, but with most banks switching to an equity line involves discharging the previous mortgage, and getting a new mortgage registered so you will likely face some legal fees.

 

Secured lines are great products but they have much more in common with credit cards than they do mortgages so keep that in mind.

[drlove 37204]

I'm getting a conventional mortgage, so they did offer me the equity line of credit. However, I'm thinking I may be better off with a fixed rate for the time being since interest rates will rise sharply after next summer (that's the prediction). I'm thinking a few years down the road...

[hunknhot 1067]

Almost all of my friends I have helped through mortgages started with a fixed 5 year term and rate. Once they went to renew they were in a better position to access products the banks don't really want you to.

 

Either way good luck! Happy home buying!