What’s Better – Paying Down My Mortgage Or Contributing To A TFSA

If you have made the maximum contributions to your RRSP (or you are in the lowest tax bracket where RRSPs may not benefit you), the next option for your long term saving is to either pay down your mortgage or contribute to a TFSA. Since a TFSA does not create a tax deduction for you (like an RRSP), the choice is simpler than the RRSP vs. mortgage debate. Generally, the one that has the higher return is the better choice.

The interest rate on your mortgage is the first place to start. It should be easy to find (or just ask your financial institution). If you are getting close to the end of the term on your mortgage, you should find out what the new interest rate will be. The rate of return on the TFSA may be more difficult to judge. That is because a TFSA can hold many different types of investments with more or less risk.

If your TFSA is invested in a savings account, the interest rate is low (but your money is liquid and safe). It is likely that the interest rate is less than your mortgage. In this case, paying down the mortgage will “earn” you a higher return.

If your TFSA is invested in a term deposit or Guaranteed Investment Certificates, the interest rate may be higher than a savings account, however, probably not as high as the interest rate on your mortgage. Again, your return would be higher if you paid down your mortgage.

If your TFSA is invested in mutual funds, then you would have to determine the possible future returns of the funds. Mutual funds that invest in treasury bills or secure bonds would likely provide a lower return than the interest on your mortgage. If you are buying a fund that holds “high yield bonds” (they used to be call junk bonds), then it is possible that the returns will be similar or slightly higher than your mortgage interest. However, there is a risk that when you go to get your money, it will have fluctuated in value and might not be worth as much as you thought.

If your mutual fund is invested in equities, then you would anticipate that over the long run, you will get a higher return than the interest on your mortgage. However, there will be much more volatility (up and down movement) in your investment. If the investment goes down and you sell your fund, then you would likely have been better paying down your mortgage. If mortgage rates are high, it is possible that equity market returns will not beat your interest savings.

It is important to keep in mind that this decision (mortgage vs TFSA) should be made with money that you do not need in the short term. Once you make an extra payment against your mortgage, it is difficult to get that money back. (You might have to re-mortgage your house to get back the equity that you created with extra payments.)

If you want short term savings (for travel or new vehicles), a TFSA is better than paying down your mortgage. For this type of saving, you should probably use lower risk investments like high interest savings accounts or term deposits.

If you are using your TFSA as an emergency fund, it should be invested in a high interest savings account, money market fund or short term deposits (30 or 60 days). You will not usually get a high return, but the money will be safe and accessible if you need it.