How to pay -2.58% after tax interest rate on your mortgage
When Boris and Bonnie’s mortgage came up for renewal late this year, we discussed using some of their home equity to catch up on unused RRSP contribution room.
The RRSP catch up strategy will help them diversify home equity into other investments, kick start their retirement savings, and save them over $204,000 in taxes over the next 5 years.
The net impact is that they are paying an after-tax cost of -2.58%. Yes, that a negative 2.58%.
- The mortgage has increased from $555,000 to $760,000, but payments are lower as they have moved to a 30-year amortization (because they intend to buy an investment property in the future and lower monthly payments let them qualify for more in the future)
- The annual interest cost on the new $760,000 mortgage, is $21,204 each year at 2.79%,
- They will generate $40,800 in tax refunds each year by contributing to their RRSP, reducing their taxable income, resulting in total tax refunds of over $205,000 over 5 years.
- After tax interest cost is ($21,204 – $40,800)/$760,000 = -2.58%.
Boris had $156,504 in RRSP contribution room available and Bonnie had $48,987 in RRSP contribution room available (total $205,491). Each will each accumulate 18% of their earned income for each future year up to an annual maximum of $26,500 each. Both earned approx. $150,000 annually.
By adding $205,000 to the mortgage on renewal, to take advantage of existing contribution room immediately, investing these funds into your RRSP’s, maximize the benefit of the tax deduction over the coming years, recycling the tax refunds into additional RRSP contributions, the additional $205,000 will fund over $370,000 in contributions / RRSP investments for the next 5 years.
By maximizing your RRSP contributions over the 5 years, Bonnie and Boris will have invested $461,000 into RRSPs from which generate $204,000 in tax refunds for a net cost of $257,000.
Before tax Bonnie and Boris are paying 2.79% 5-year fixed rate on a refinance, which was the best rate available in Canada for an “uninsurable” mortgage. After tax, the Bonnie and Boris are paying MINUS 2.58%. I find it amusing when clients ask me “what is the best interest rate”. It depends on a numbers, but it’s clearly not the right question to be asking.
Let me know if you need a plan to lower your interest rate, reduce your taxes, and diversify your investments.