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Reader Question: Debt or RRSP?
I received this email from Greg regarding optimizing his finances. I thought it would be a great email to post to the public as it could be helpful to others.
My name is Greg, I’m 23 living in Vancouver with my wife (who is currently unemployed, still working on immigration stuff), I make $45k/year and I just had a few questions for you.
Being in Canada, how can I go about finding out my credit score? I’ve found a ton of info on this for the US, but nothing for Canada and I don’t trust the sites I have found since they don’t look legit.
Another question I have is more on the financial side. I have $10k in student loans left, along with $5k on a credit line. I put $100 into RRSP’s every month and other then that I do no saving. I pay $150 to my student loans every month and $100 to my credit line and I was just wondering if you have any suggestions as to what else to do? I just got a raise from 40 - 45k, so I’ll be bringing in an extra $150 - $175 per check. Is it better to take that $100/month from RRSP’s to pay down my debt more? Should I use my extra funds to focus on paying down debt, building an emergency fund, building a savings or increasing my RRSP contributions?
Lastly, and I apologized for all the questions. :) What do you recommend as a good way of getting into investing (over and above RRSP’s)? I’d like to try tinkering in some cheap stocks, but like many others I’m clueless on where to start.
More details:
- Student loans are Canadian and provincial rate @ prime after tax break.
- Credit line rate is @ 9.6%
There are two major credit bureaus in Canada, Equifax and Transunion. My favorite free way to get my credit report is through Equifax. Their automated service number is: 1-800-465-7166. Calling this number will bring you through a series of questions like SIN, address etc to verify your identity. After your identity is confirmed, they will mail you a free copy of your credit report. This report however, will not give you your credit/beacon score. If you want your beacon score, you will need to purchase the score from the Equifax website. I believe that it costs $24 for this service.
In terms of your debt, your credit line is public enemy #1. This is what I would do:
1. Pay the bare minimum on your Canada student loans as the tax rules will give you a tax break on the interest that you pay.
2. Increase your credit line payment as this debt is non tax-deductible and the rate is ridiculously high (IMO).
3. If your employment does not match your RRSP contributions, I would consider stopping them and applying them to your credit line until it is paid off. OR, you could continue doing what you’re doing, and using your tax refund to pay down your credit line.
4. After your credit line is paid off, increase your student loan payment and continue making your RRSP contributions. Any extra income (tax refunds, blog income etc) should be applied against your debt. Even though you have paid off your credit line, I would consider keeping it as part of your emergency funding. I, for example, keep a $10k personal line of credit for emergencies.
As you live in BC, if you are considering investing outside of your RRSP, you should look into dividend paying stocks as you can make up to $70k in income and dividends without paying any tax on the dividends. I personally would not even consider dabbling in small cap stocks until you pay off all your debt and have some discretionary income to spend. Playing with small caps can be risky business and the capital used should be that which you can afford to lose.
Hope this helps put some insight into your finances Greg. Feel free to add any additional questions you may have in the comments.
Anyone have anything to add? Disagree with my commentary? I look forward to a discussion in the comments.
If you have a personal finance question, feel free to contact me and I’ll try to help out where I can!
Disclaimer: Please note that this is my opinion only and should only be followed at your own risk.
10 Comments, Comment or Ping
1. Financial Blogger
I totally agree with your comments. In the process of debt elimination, you must concentrate all your monthly cash flow on the highest interest debts in order to get rid of it ASAP. I previously did some calculations showing the impact of this process. You can look it up: http://www.thefinancialblogger.com/?p=26
May 15th, 2007 @ 8:29 am
2. ThickenMyWallet
Very prudent suggestions. In terms of investing, I would suggest that Greg go to the library and read some books before buying anything and model himself after a strategy/investor he is comfortable with and which is successful.
May 15th, 2007 @ 11:41 am
3. Soultrance (Greg)
Thank you very much for all the suggestions, they are greatly appreciated. I think my mind just changed from wanting to invest my extra cash to putting it on my debt instead.
Thanks again!
Greg
May 15th, 2007 @ 1:07 pm
4. FrugalTrader
Greg, since your credit line is ~10%, paying it down is equivalent to a guaranteed pre-tax gain of around 13%. There is nothing out there that has a guaranteed return of 13%.
May 15th, 2007 @ 1:11 pm
5. Q Cash
FT
Sound advice as always.
My only comment to Greg would be if you can manage it, keep up with the RRSPs. My reason is that it keeps the discipline of the forced savings in place while you deal with your debt reduction. This forced savings can be used towards a home purchase later on through the HBP.
If you can manage it, the full amount of your raise should be put against the credit line (9.6% is high and FTs comment about an automatic 13% return equivalent by paying it off is valid.)
As soon as it is paid off, I would increase the RRSP payment by half the Credit line payment and increase your student loan by the other half. As soon as that is paid off, increase your RRSP contribution to the full amount.
Once you are maxing out your RRSPs, you can then look at dividend producing investments outside the RRSP.
Just my few cents worth.
The other option is to go on a strict spending diet for 6 months and pay off the full amount ASAP, but that may require sacrifices you don’t want to or have to make.
Finally, go easy on yourself. If you only have $15,000 in debt with a $45000 a year salary, you are not starting off with too bad a situation AND you are already making the RRSP contribution. Well done.
Q
PS If you want to have that emergency account, might I suggest a PC Financial or ING high interest savings account. Throw $50 a pay through an automated savings plan and you will be in good shape in a year or two.
May 15th, 2007 @ 2:58 pm
6. Warren
Good advice all.
What is the advantage of getting the report vs. the beacon score. Does the $24 provide a more detailed version of the report as well?
In otherwords, is it worth it? :)
May 15th, 2007 @ 4:32 pm
7. FrugalTrader
The beacon score will show what a lender would see. Basically, the higher the score, the better the rates that you’re going to qualify for.
The report itself simply shows all the credit lines that you have (minus mortgage) and the status of the accounts.
May 15th, 2007 @ 4:36 pm
8. FinancialJungle
Q wrote: “My reason is that it keeps the discipline of the forced savings in place while you deal with your debt reduction. This forced savings can be used towards a home purchase later on through the HBP.”
Debt reduction is a form of forced saving. Since paying down the credit line is equivelant to a guaranteed return of 13%, I’d still pay off the credit line first. I’m not sure how safe is it to investing in the stock market, since TSX had a pretty good run over the past 5 years.
May 15th, 2007 @ 11:44 pm
10. Henry
Sounds good to me.
Dec 10th, 2007 @ 2:00 pm
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