Do you have a mortgage? Do you save up for your next vehicle purchase using savings account(s), which on the surface appears to be a wise move? Well stop it!

Why Savings Accounts Are Not the Answer

While saving up for that vehicle using savings accounts is admirable in this day and age where many people finance or lease, it’s actually not the optimal path to take for two reasons:

1. You’re paying taxes on that interest savings account.
2. You’re paying interest on your mortgage.

The Answer

There is a better way to do it. Put that savings against your mortgage instead and then borrow it back when you actually need the money for your next vehicle. See Canada Mortgages for up to date information on mortgage rates.

Let’s do a comparison:

Option #1 – savings account

You put $300/month into a savings account at 4% for that next vehicle you’ll need in four years. At that point, you’ll have $15,565 saved up and have earned $1,165 in interest. All of that interest is taxable at your marginal rate. If that is 31%, you’ll actually have $15,203 after taxes.

Option #2 – mortgage paydown

You put the $300 against your mortgage instead, which say is at 5.5%. After four years, your mortgage will be reduced by $16,022 and you will have saved yourself $1,622 in interest. There is no tax consequences with this option.

For simplicity’s sake, let’s say the vehicle you purchase costs exactly $15,203. With the first option, you withdraw the money from your savings account, buy the car for cash and you’re left with nothing. With the second option, you borrow back from your mortgage the $15,203 and you are left with a $819 benefit! You have paid down your mortgage by $16,022 over the four years and are now taking back only $15,203, so your mortgage balance is $819 lower than it would be with the other option!

What You’ll Need

How do you borrow money back? There are a couple of ways.

• Set up a Home Equity Line of Credit (HELOC) when you are ready to purchase your vehicle; a HELOC can be considered part of your mortgage, just one with a revolving credit portion.

See your banks for a HELOC. RBC and TD offer them, among others.

• Time your vehicle purchase with your mortgage renewal and simply add the amount you need into your new mortgage.
• Do an equity takeout, which is similar to the previous option, but without having to do it at renewal time.

Closing Notes

Remember, you are not actually borrowing any money! You are simply overpaying your mortgage and then taking back that money when you need it. The benefit comes from interest savings (mortgage rate is higher than savings account rate) and from avoiding taxes on the interest.