Couple needs a 'pay yourself first' strategy

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With the arrival of their second child last month, Emile and Julie decided it was time to sharpen their pencils and have a long, hard look at the family budget.

After all, their goal is to have the house paid off by the time Emile turns 50. He is 38, while Julie is 32. If they succeed, Emile's plan is to celebrate by taking the family on a three-month cycling adventure in Australia and New Zealand.

Emile earns $125,000 plus bonuses that lift his annual salary to $160,000. He works in information technology but his contract for his current job will be up in a couple of years, creating some short-term financial uncertainty.

Julie, a nurse, earns $55,000 but plans to take a couple of years off to take care of their newborn and two-year-old.

Given their focus on repaying their mortgage loan, Emile wonders whether it would make sense to hold it in his self-directed registered retirement savings plan. With his RRSP now bigger than the $159,000 mortgage on their Montreal home, "the thought of paying myself the interest on my mortgage is an appealing one," Emile writes in an e-mail.

"But is this a wise thing to do?"

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We asked Gilles Couturier, regional vice-president, at T.E. Wealth in Montreal, to look at the couple's situation.

What the Expert Says Emile and Julie's strategy has been to contribute the maximum to Emile's RRSP ($21,000) and apply additional family savings (about $20,000) to the mortgage over and above their regular bi-weekly payments, Mr. Couturier notes. They also have an emergency fund. Their total savings rate is 19 per cent of the family income, which is "very good."

Despite their fixation on paying off the mortgage, the planner suggests they contribute as much as possible to Julie's RRSP because she has some unused room.

"The tax-free compounding of the returns over time works significantly in their favour, while any tax refund can be applied against the mortgage," he says.

Julie and Emile's approach to budgeting is to save what is left after expenses, the planner says. This works if the family income is stable or rising, but with Julie taking some time off, neither Julie nor Emile are sure of just where all the money is going.

Mr. Couturier suggests tracking spending more closely by adopting a "pay yourself first" strategy. That way, savings goals will be met and they can "spend whatever is left as they see fit."

As for holding the mortgage in Emile's RRSP, three things have to be considered. First the costs, which can be considerable: set-up costs such as mortgage application fees, bank fees, appraisal fees, legal fees and mortgage insurance premiums that could range from $2,500 to $7,500. Then there are annual or periodic costs, such as a mortgage administration fee, a renewal fee when the mortgage term expires and a self-directed RRSP fee that could run from $500 to $700 a year. To free up the money within the RRSP, investments may have to be sold, giving rise to sales commissions.

Second is the question of yield. Is the mortgage rate higher than what Emile could earn on comparable investments such as guaranteed investment certificates or bonds?

Third, does he want to invest that much in fixed income at his relatively young age? In so doing, he would be lowering his long-term growth prospects, Mr. Couturier says. Emile's current holdings are about 60 per cent stocks and 40 per cent fixed income.

"If he were to hold his mortgage in a self-directed RRSP, there is a probability he would limit his long-term growth and the benefits he could derive from his RRSP during retirement."

So what about the cycling trip Down Under to celebrate the final mortgage payment? Will they have the loan paid off in 12 years?

Easily done, Mr. Couturier says. If Emile and Julie top up their regular payments by at least $12,000 a year - which is less than what they are doing currently - they will eliminate the mortgage by then.

As for Emile's job uncertainty, "his skill set will likely continue to be in demand and any transition in job circumstances should be temporary in the grand scheme of things."

Client Situation

Special to The Globe and Mail