Quick note before we start: this article shares general ideas about the high-interest debt vs. investing question in Canada. It's not personal financial advice, and everyone's situation is different.
Should You Pay Off Debt or Invest?
Every Canadian with a bit of extra money asks this: Should I throw this cash at my loan or credit card, or should I drop it into my TFSA (Tax-Free Savings Account) and start investing?
It’s tempting to jump into investing. You see the headlines about big returns. But that looming debt often feels like a giant anchor.
The good news? The answer is not always “one or the other.” The decision is actually a mix of simple math and personal psychology.
Here is the straightforward breakdown to help you decide your next financial move.
1. The Math Rule: The Guaranteed Return
The fastest way to decide is to compare the interest rates. This is the Math Rule.
When you pay off a debt, you earn a “guaranteed return” equal to the interest rate you avoid paying.
How to Calculate Your Guaranteed Return
- Step 1: Look at Your Debt Interest Rate. A credit card might charge 22%. A line of credit might charge 8%. A mortgage might charge 5%.
- Step 2: Look at Expected Investment Returns. Historically, a well-diversified stock market portfolio (like one you’d hold in your TFSA or RRSP) has averaged about 7% to 8% per year before inflation. And this return is not guaranteed—it can be 20% one year and -10% the next.
The Decision: Debt Rate vs. Investment Rate
- If your Debt Rate is HIGHER than your Expected Investment Return (e.g., 22% vs. 8%):
- Pay off the debt. Nothing you invest in will safely or reliably earn more than the 22% you save by crushing that credit card balance. That 22% is a guaranteed, tax-free return on your money.
- If your Debt Rate is LOWER than your Expected Investment Return (e.g., 5% vs. 8%):
- Invest. The math suggests you will likely come out ahead by paying the 5% interest and aiming for a higher 8% return in your TFSA or RRSP.
Example 1: Math First (The Story of Maria)
Maria has a $5,000 credit card balance leftover from fixing her roof. The card charges a punishing 23.99% interest. She also has $5,000 she could put into her TFSA, where she hopes to earn the market average of 8%.
The Dilemma: Should she invest the $5,000 or pay off the card?
The Math Solution: If Maria invests, she makes a potential 8%, but she pays a guaranteed 23.99%. That means she loses a net 15.99% every year on that money. By putting the $5,000 toward the credit card, she instantly gets a guaranteed 23.99% return by avoiding the interest cost. She must pay the debt.
The Big Exception: High-Interest Debt
In Canada, any non-tax-deductible debt over 8–10% should almost always be paid off first. This includes nearly all credit card balances, personal loans, and payday loans. These high rates can outpace even the best investors. Crush the high-interest debt first.
2. The Behavioural Rule: Sleep-at-Night Factor
The math is important, but personal finance is more personal than finance. This is the Behavioural Rule.
You might have a debt with a low-interest rate, say 4.5% (like an old student loan), where the math says, “Invest instead.” But carrying any debt stresses you out.
This stress has a real financial cost.
- Debt Anxiety can lead to poor choices: If debt is stressing you, you are more likely to make panicked, emotional investment decisions later on.
- Mental Freedom is a Head Start: Paying off a low-rate debt gives you a huge mental win. You free up that monthly payment, and now that money can go straight into your TFSA or RRSP without guilt.
- Guaranteed vs. Potential: Eliminating debt is a guaranteed win. This psychological safety allows for more consistent investing later.
Example 2: Psychology First (The Story of Pierre)
Pierre has a $10,000 student loan at a low, fixed interest rate of 4.5%. He has enough cash to pay it off, but the Math Rule says he should invest in his TFSA to chase the expected 8% market return.
The Dilemma: Math says invest, but the loan weighs on him. He sees the payment leaving his bank account every month and it makes him anxious, distracting him from long-term goals.
The Behavioural Solution: Pierre decides to pay off the loan. Yes, he gives up the potential 3.5% gain in the short term. But the day he pays it off, he feels a massive mental relief. He immediately directs that former loan payment (say, $200 per month) into his TFSA. This clean start means he’ll invest consistently for the next 30 years without the debt anxiety—a huge long-term win that far outweighs the small initial math loss.
The Canadian Tax Context: TFSA vs. RRSP
If you are a Canadian investor, the choice to invest usually means maximizing your registered accounts.
- TFSA (Tax-Free Savings Account / CELI): The growth inside your TFSA is never taxed. You pay off a 20% credit card and then grow your money tax-free in your TFSA? That’s an unbeatable double-win.
- RRSP (Registered Retirement Savings Plan / REER): Contributions are tax-deductible, giving you a refund now, but withdrawals are taxed later. If you are struggling with high-interest debt, maximizing your TFSA room is usually the more flexible first step after clearing the debt.
Don’t feel pressured to rush a deposit into your TFSA (or RRSP) just to use your contribution room. That room carries forward forever! Your $20,000 of available room will still be there next year. What won’t wait is the 22% interest you’re currently paying on that credit card. Take care of the guaranteed, painful loss first.
The Debt vs. Investment Flowchart: Your Next Step
Use this simple, step-by-step priority list for your extra cash.
- Fund Your Emergency Account: Do you have 3–6 months of living expenses saved in a high-interest savings account?
- If No: Stop everything and fund this first.
- Crush High-Interest Debt: Do you have any non-tax-deductible debt (credit cards, line of credit, etc.) with an interest rate of 10% or higher?
- If Yes: Put all extra money toward this debt.
- Address Medium-Interest Debt: Do you have debt between 5% and 10% (e.g., car loan, student loan)?
- The Choice: Here, the math says you could invest, but if it causes you stress, pay it off. If you are comfortable taking on calculated risk, start investing in your TFSA.
- Start Investing: Is your only remaining debt a low-rate mortgage or no debt at all?
- Your Next Step: Start small. Open your TFSA and set up an automatic monthly transfer. Focus on consistent, long-term contributions.
Reader Takeaway
The decision of whether to pay off debt or invest is not complicated. Always eliminate your high-interest debt first because it provides a guaranteed, tax-free return that no investment can safely beat. Once that anchor is gone, you gain both the math advantage and the psychological peace of mind to invest consistently for the long term.
Ready to dive deeper into the powerful benefits of Canadian tax-sheltered accounts? We break down the key differences here : TFSA vs. RRSP: Which Savings Account Is Right for You?
Full Disclaimer
The content in this blog post, including all opinions and calculations, is provided for educational and informational purposes only. It is not financial, legal, or tax advice. We are not responsible for any actions taken based on the information provided here. Always consult with a certified financial professional who can assess your specific personal situation before making major financial decisions.
