Booo! Hissss! to Catch-Up Loans
Posted by Gail | Filed under Debt Traps
I received a question from Beverley who wanted to know what I thought about borrowing money to catch-up unused RRSP contribution room – you know, all those contributions you didn’t make because you’d spent all your money!
I thought this might be on more than one person’s mind since it’s RRSP season and the marketing material is flying in the door at a wicked clip. Remember, by its nature, marketing material is designed to show you the positive side of a strategy so you’ll want to take advantage of the “offer.” But not all offers are worthy of your attention.
Beverley borrowed $65,000 last year and thinks she might borrow again this year to complete the catch-up of her unused RRSP room. These “Catch Up Loans” were popularized by a particular bank that sold the pants off them, and laughed all the way to the vault.
If she goes through with her plan, when all is said and done, Beverley will have an outstanding loan of $103,000 at “prime” (because she’s tied the loan to her home equity) and plans to repay $1,000 a month.
It will take over TWELVE YEARS for Beverley to repay this loan.
It will cost Beverley over $42,000 in interest by the time the loan is repaid, assuming her interest rate does not go up one iota over the next decade. Hmmm. I wouldn’t take that bet!
Do I think this is a good idea? I DO NOT.
I hope Beverley’s income is high enough – in this case well over $100,000 a year – so she’s getting full use of the RRSP tax deduction? If not, then what’s the rush? Keep in mind, too, that if interest rates go up Beverley could find her payments increasing putting more pressure on her budget, since the loan rate is only fixed for the first year
With loan repayment eating up a large slice of her budget pie, will Beverley be able to afford to make her regular RRSP contributions?” If the answer is “No”, at the end of the catch-up loan, she would have to catch up the contributions she didn’t make while she was repaying the loan. Sounds like a Catch-22 to me.
Here’s an option Beverley might want to consider instead of taking out another loan. She could make her maximum RRSP contribution for this year using a monthly investment plan. Then she could also contribute the amount she would have made in loan payments to her RRSP on a monthly basis. It may take a little longer to catch up, but she would have no interest costs. All her money will be working for her, instead of making a bank even more profitable.
I wonder, too, if Beverley knows what the Alternate Minimum Tax (AMT) is? The purpose of the AMT is to ensure that people who make a certain amount each year don’t get off scot-free tax-wise by accumulating deductions. She should do the AMT calculation before deciding how much she will catch up at one time.
I’m not a fan of catch-up loans. I think they play into people’s needs for immediate gratification. And that immediate gratification comes with a heft price tag. In Beverley’s case, that would be over $42,000 in interest.
We’re moving into very uncertain economic times. The US economy looks like it’s headed for the dumper. The markets are zipping and diving, dodging and weaving. No body knows what’s going to happen next. And we haven’t seen the last of the billion-dollar write-downs for misjudging the credit marketplace. This is no time to be taking on debt.
Saving and investing are long-term, slow and steady propositions. If you want to catch up your RRSP unused contribution room, trim back on your expenses or make enough extra money to sock away what you want. Don’t borrow it.
January 18, 2008 at 10:32 am
Right on. People should not borrow to invest, including investing in a RRSP. This is a bad idea. That lady took a home equity to fund her RRSP.
What if the housing market heads south, like it is doing in the US right now? What if she has to sell her house for whatever reason, and end up owing more on her house than what it is worth? These times are too precarious. A major depression is coming. It is not time to borrow, but time to pay down debts.
January 18, 2008 at 11:49 am
I agree with you here, Gail. There’s a reason banks push these loans – they’re ridiculously profitable. They lend you the money, then you turn around and give it right back to them through investments, which the bank in turn makes even more money off of.
As you mentioned, the best strategy is planning ahead instead of catching up.
Funny though, when I was a banker I would encourage people to do just that – set up that monthly (or bi-weekly) RSP contribution now so they don’t have to do an RSP loan at the last minute… and you would be amazed (or maybe you wouldn’t) at how many customers balked at the idea of planning ahead.
January 19, 2008 at 4:11 am
Gail, you are so right!!!!!! I’ve been trying to figure out HOW someone can justify borrowing money for their future savings?! I’m sure its not the same thing, but it is almost like trying to justify taking a $500 cash advance on your credit card to put in a savings account. Probably making less than 1% on your balance. I just don’t get it.
The people who buy into this idea are not entirely responsible for thinking its a good one. Banks are horrible for trying to convince you that taking out money on a home equity line of credit is a good way to catch up on your unused RRSP’s. And if these people are going in to these banks asking for advice, they’re under the impression that they’re being told what’s best for them.
I just say find a way to spend less, save more, and keep that interest from the investments in your pocket.
These are definitely not the times to be accumulating more debt, but saving as much money as you can. In hard earned cash!
January 24, 2008 at 5:32 pm
Peaches0143: I can speak from experience as a banker that the advice you may receive there can be hit and miss. It depends on who you talk to at the bank. There are some people working in these places who are very talented and will recommend what is best for you financially. Unfortunately, there are just as many that will recommend whatever product the bank is pushing at the moment.
Also keep in mind that you sometimes may be hearing what IS best for you, but it just might not be what you want to hear.
February 15, 2008 at 10:13 am
An RRSP loan would only make sense if you expect to have a rate of return in the RRSP that would be vastly superior to the interest rate on the loan. Not a guarantee by any means. Yes, there’s the benefit of compounding of that lump sum, but the advantages are not universal to everyone. Some people also use them because they’re forced to make a loan payment but don’t have the discipline to make regular contributions. Dumb. RRSP solutions are not one size fits all and people should educate themselves about what is best for them.
January 22, 2009 at 7:10 am
[...] are have been using the catch-up RRSP loan as a way to pin people’s wings to the table for years. I’ve written about it before. But this letter from Marlaina really brings the point [...]
August 11, 2010 at 1:53 am
please explain to be how you come up with $42,000 in interest borrowed at prime over 12 years. I calculated around $14,000
thanks
March 10, 2012 at 10:16 am
I’m also calculate as like as wallace. I have the same digit. Let me know the perfect. Thanks for this allocation.
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