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RRSP loan strategy to bid adieu to credit card debt.

Posted on 30 January 2014 by admin

By Lachman Balani

Toronto

As reported in some financial magazines ,newspapers and other media, many clients are debating whether to pay down their credit card and/or line of credit debt rather than invest in an RRSP. Several are opting to pay off their debt rather than contributing to their RRSPs. However, here is a strategy to help you get the best of both worlds.

Let us suppose that you are an average person in Ontario (this works for anybody living anywhere in Canada) earning a salary in the 31.15% tax bracket and have an average perennial credit card debt of say $10,000 which, no matter how hard you try, you are unable to get rid of. Some months it may jack up to $12,000 and other months it may be at $8,000, but on the average it is always around $10,000. The interest rate on a balance is usually in the ball park of 18-20%.The minimum payment on this debt is usually about 3% of the total or $300. What follows is an outline of the strategy to bid adieu to this ‘bad’ debt and to build your assets by taking on a ‘good’ debt. A ‘good’ debt is used in the sense that the debt helps in building wealth for the future.

The Strategy 

 

As mentioned before you have a perpetual debt of $10,000 and instead of contributing the usual $5,000 to an RRSP that you do annually you wish to use it to pay down your debt.

If you have been in the workforce for several years and have a lot of RRSP contribution room, as is the case with most people in Canada, you can avail of what is known as a ‘catch –up’ loan (to catch up on all your available RRSP contribution room). This loan is payable in 10 years and is available at an interest rate of prime + 2.75% or 5.75% currently (the prime rate is at 3%). Should you shop around, you may find loans at cheaper rates, but I am here using a rate that many institutions offer. If you take an RRSP loan of $25,000 at 5.75%, the monthly payment is $283 (less than the minimum payment of $300 on your credit cards) if you take a 6 month deferral on the first payment. The reason you want to avail of such a deferral is that you should wait for your tax returns to pay down your credit card balance.

For simplicity, once the loan is approved and funded, you will get a tax refund of 31.15% on $25,000 or $7,787.50 once you file your tax returns in April. Since you were planning to use $5,000 anyways to pay down your debt, all you need to do now is add $2,212.50 from this $5,000 you have set aside and pay off your entire credit card debt of $10,000( $7,787.50{tax returns} + $2,212.50{own money}= $10,000) and still have $2,787.50 left over to invest or pay down your mortgage.

In summary, instead of using $5,000 to pay down your debt by half,

1. Take an RRSP loan of $25,000 and pay off the entire credit card debt so that you now have zero credit card debt.

2. You now have $25,000 invested in an RRSP, which if invested properly will grow over the years.

3. Plus you have $2,787.50 left over to do as you please.

4. However, remember that you still have to service the RRSP loan with a $283 monthly payment, less then servicing your ‘bad’ credit card debt with a monthly $300 payment.

Please note the above is an overview of the strategy.

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