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I own a car which I had bought under desperation and stupidly agreed to pay a high interest rate (8%). Recently, I used money from my line of credit, which was at 6%, to pay off my car loan. Now I want to get rid of that line of credit as soon as possible.

I put in about $200 every month to pay off the line of credit (that's what I can afford right now). I was talking to a financial advisor about this and he suggested that I use the money I contribute to my RRSP and TFSA (about $500) every month to pay off the loan faster.

I have never though about this option and I am not sure whether it is a good idea to stop putting money into my saving to pay off a loan, so I though I would reach out to the people here.

Do you think it is a good idea to stop putting money into my savings and pay off the loan instead?

I did some math (or an online calculator did):

  • If I just put in $200 monthly it will take me about 50 months to pay off the loan and I would pay an additional $1194.19.

  • But if I put in $700 monthly I can pay off the loan in about 14 month and pay only $341.15 extra.

When I look at this, the choice seems obvious, but I have no way to estimate the potential savings loss if I go for option 2 ($700/month).

I should mention that I also have shares whose value is almost equal to the amount I have to pay off, but I am really reluctant to use that because I know these shares will go up more.

Chris W. Rea
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Abhishek Asthana
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2 Answers2

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To give a general answer to a specific question - you should place your money where it gives the best rate of return. The rate of return on making an investment is the interest (or dividends, growth etc.). The rate of return on paying off a debt is the interest you don't have to pay on the loan you paid off. It's not about how long it takes to pay off the loan.

The rate of return on paying off your line of credit is 6%.I don't know the rate of return you are getting on your RRSP or TFSA investments, but it is probably not 6%. Your financial advisor should know, anyway. If it is less than 6% then you should pay off the loan first. Since your financial advisor recommended this, that is probably the case.

The important exception is the matching of your RRSP contributions. This earns an effective 100% rate of return. Absolutely keep on making that 3.5% contribution. See this question for more information. EDIT: based on comments, the 3.5% isn't an RRSP match which makes it less certain that it's a great investment. That would be too complicated a question to get into here.

You should consider keeping some money in an 'emergency fund', i.e. somewhere you can get at it quickly and cheaply if you need it. RRSPs aren't a good emergency fund. TFSAs can be if the funds aren't invested in something with a withdrawal penalty. In your case I would advise treating the spare space in the line of credit as an emergency fund. in other words, if you pay off $5000 from your line of credit, and find you need $5000 urgently you take it back out of the line of credit again.

Finally, and most importantly, if advice you get on this site or from any other random strangers on the internet contradict your financial advisor, believe your financial advisor.

Community
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DJClayworth
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    The last line is too broad a generalization. When an advisor recommends a high load fund or high comission variable annuity, he has a vested interest in pushing a product. We random strangers have nothing to gain. – JTP - Apologise to Monica Nov 28 '13 at 05:05
  • Yes -- the advice industry is fraught with conflict of interest and advisors in Canada aren't held to a fiduciary standard. Caveat emptor. There are good advisors, but there are plenty of salespeople too. Prefer advisors that charge only a flat fee and don't earn commission from selling investments. – Chris W. Rea Nov 28 '13 at 12:26
  • My company matches 3.5% but that is not in an RRSP instead in a TFSA. That said thank you very much for your answer I agree I need to look at how my investments are performing to see where I am getting the highest rate of return and if the rate of return on my Line of credit is higher I need to use money I am putting into my saving to pay off the line of credit. – Abhishek Asthana Nov 28 '13 at 12:37
  • Its not easy finding a financial advisor you can trust, fortunately I have one in Canada. Don't even ask how my search for a financial advisor in India is going. I think a good rule or thumb is to have more than one financial advisor in a country so that you can consider both of their advises and choose the one that makes most sense. – Abhishek Asthana Nov 28 '13 at 12:39
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    While I agree that not all financial advisors are worth the money you pay them (even if they are free), there are two reasons I recommend paying attention in this case. 1 - he has already suggested the switch to paying off debt, which will mean less commission for him and proves he isn't purely basing his advice on how much commission he makes 2 - he knows the likely rates of return much better than we do. – DJClayworth Nov 28 '13 at 15:48
  • I actually went with my (other) financial adviser's advice. he suggested i use debt stacking to pay off my loans. I was originally putting in about 500 CAD every month for that instead he suggested a smaller amount so that I would end up paying off all my loans in the same amount of time with less money every month. I am using the left over amount to create an emergency saving for my parents and in-laws. Sorry it took so long to accept an answer, i totally forgot about this question till the Christian org lady answered :) – Abhishek Asthana Apr 09 '14 at 11:49
  • What about the income tax savings of paying into RRSP? Can the saved taxes make it a better investment than paying off a low interest debt? – IronSean Feb 21 '18 at 15:48
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I'd suggest you continue the deposit of 3.5% of your salary, and use the additional funds to pay down the loan. A 6% annual interest rate doesn't take priority over a 100% match.

JTP - Apologise to Monica
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  • You are correct, none of my investments have performed as well as my company's shares. The 3.5% contribution is out of my hand, its deducted from my salary even before I get it. Its the amount I put into my other savings that I plan on using to pay off the LoC. – Abhishek Asthana Nov 28 '13 at 12:46