Some Canadians will take out TWO RRSP loans at the same time. Your first question might be, "Why not just get one bigger loan?". The answer (for them) is cash flow management. This strategy is similar to a traditional RRSP loan except if you know you are going to apply the tax refund towards reducing the monthly payments – this is an alternative way to do that which ensures your monthly cash flow directed towards the RRSP Loan repayments are reduced from the get-go.
Let’s again look at our example Canadian, Joe. He earned $50,000 last year, and let’s say he wants to contribute $9,000 in total. According to the now familiar Ernst & Young RRSP Savings Calculator, we know his refund will be approximately $2,804.
Instead of getting one RRSP loan for $9,000 – he will get one that is equal to the tax refund ($2,800) and one for the balance ($9,000 – $2,800 = $6,200). In addition, he will elect to defer starting the payments on the $2,800 loan for 6 months – this is more than enough time to get his tax refund back which he will use to pay off the $2,800 loan altogether. Now he is just left with the payment on the $6,200 loan all along.
Let’s compare monthly payments:
A 1 year loan for $9,000 at 6.5% interest requires a $777 monthly payment.
A 1 year loan for $6,200 at 6.5% interest requires a $535 monthly payment.
The $2,800 loan doesn’t ever require a payment since you have deferred the first payment for 6 months – and before that time comes, you will have received your tax refund and applied it against the loan and paid it off entirely. Keep in mind you will have to pay a little more than $2,800 since interest accrues from day one – so the amount required to pay off the loan will be closer to $2,860 if you wait 4 months to pay it off (for example).
Remember, this is one of those "six of one, half-dozen of another" scenarios. You could easily just get one big loan and apply a lump sum payment to it when you get your refund and have the bank reduce the monthly payment at that time.
Quick quesiton. If you simply take the 9000 loan and apply the lump sum refund against the loan, will the bank ALWAYS reduce the monthly payment, as you indicate at the end of this article? What is the process to do just that?
@cons-ig-eb: No, the bank will not always reduce the monthly payment – you should discuss with them ahead of time as they may just reduce the principal owing and continue with the same monthly payment requirements. The process just involves talking to your bank/finance company ahead of time to inform them of your intentions and then they will tell you what the specific process is for them. Thanks for your comment.