Angel emailed me to request some personal finance direction. Angel is basically wondering if it would be wise to get an RRSP loan and use the tax refund to pay down the car loan. Here are more details:
I'm a 22 year old from Winnipeg, MB. I make about C$35,000 (pretax), and have no debt, other than my car loan (~$7000 @ 11%). I'm got the equivalent of a month of expenses in Savings, and I just started saving about $100 in RRSPs every month. Since I had not done any contributions previously, my RRSP limit is about $10,000.
I was told by a friend that I should get a $10,000 loan (@ prime) and put that money on my RRSPs, and use the tax deduction to lower my car loan balance. Does this make sense to you? I understand that you're not a financial advisor.
In MB for 2007, the first $30,544 of income puts your tax rate @ 26.4% and $30,544->$37,178 has a tax rate of 28.50%. With that said, making $35,000 gross puts your tax rate @ 28.5%.
If you were to get a $10,000 loan, you would get a refund approximately (28.5% x 5000) + (26.4% x 5000) = $2745. This would account for less than half of your car loan. Not only that, since you're in a lower tax bracket, your return is not optimal. There could be arguments that you'll have half of your car loan paid off, along with a good start to an RRSP (compound growth over the years). Especially since you are young. However, you are still left with an RRSP loan of $10,000 @ prime on top of $4,200 @ 11% left on the car loan. Now you face 2 payments, the regular car payment + RRSP loan.
If it were me, not unless your rrsp contributions are employer matched, at your current tax bracket I would stop RRSP contributions. I would then put all contribution money and extra savings towards the car loan. The reason being, @ 11% interest, paying down the car loan is equivalent to a 14% pre-tax investment return at your marginal rate. In a couple years when you jump tax brackets and your car loan is paid off, I would take your former car payments + cash flow and max out the RRSP (as much as possible anyways).
Personally, there are very few scenarios where I see RRSP loans beneficial. The one case where I do like RRSP loans is where the loan "tops up" your RRSP contribution and the tax refund pays back the loan entirely.
Any financial advice that I give should be taken as opinion only and not as professional financial advice.If you would like to read more articles like this, you can sign up for my free weekly money tips newsletter below (we will never spam you).