The 5-per-cent return on safe investments is back.
It happened last week when major banks increased their posted mortgage rates. If you were lending money out for mortgages like a bank, you could get the same return.
Here’s how: Just use the money in your registered retirement savings plan to finance your mortgage.
Investing your RRSP dollars in your mortgage is a fringe strategy – let’s get that straight. Several financial institutions offer it, but not with much enthusiasm. It’s costly and time consuming to set up, and it locks you into returns that could be lower than what a diversified investment portfolio could earn over the long term. If your entire RRSP is invested in your mortgage, then there’s also a lack of diversification to worry about.
And yet, there’s a steady level of interest in this strategy. Mike Wise, a Calgary investment adviser, said most of the inquiries he gets are from people who want to use RRSP money as a source of funds to buy investment real estate. These people are often stretched financially and may not qualify for traditional mortgages.
The other group interested in the mortgage-RRSP strategy is made up of conservative investors who see their mortgage as a potential replacement for the low-yielding bonds and term deposits they own.
“That kind of person would be a jewel for this strategy,” said Mr. Wise, who 11 years ago put his own mortgage in his RRSP and wrote about it for Canadian MoneySaver magazine (read it here).
Charley Tsai, vice-president of wealth planning support at TD Waterhouse, offers this guideline on deciding whether it makes sense to hold your mortgage in your RRSP: “It’s worthwhile if the mortgage interest rate, net of expenses, would be greater than the investment return you would generate from your RRSP.”
Let’s deal with the “net of expenses” side of things first. Prepare yourself for a fee-for-all if you set up what banks call a non-arm’s length mortgage.
Start with the mortgage set-up fee and annual mortgage administration fee, which at TD are $250 and $225, respectively. Next, there are legal fees that can cost, in one mortgage broker’s estimation, anywhere from $500 to $1,000, depending on the specifics.
Now add mortgage insurance fees that will apply regardless of how much equity you have in your home. Genworth Financial, a private provider of mortgage insurance in Canada, says the insurance premium on mortgage amounts ranging as high as 65 per cent of the value of a home will be 0.5 per cent of the amount borrowed. Premiums rise as high as 2.75 per cent for mortgages that are up to 95 per cent of a home’s value.
You could face still another fee if you break an existing mortgage so you can move it into your RRSP. For that reason, the best time to adopt this strategy is when your mortgage comes up for renewal.
Negotiating the mortgage
When negotiating a typical mortgage, your goal should be to hammer the rate down as far as it will go. Just the opposite applies with an RRSP mortgage, because you are essentially paying interest to yourself, not the bank.
“If you’re doing this, you want to try and have as high an interest rate as possible,” Mr. Tsai said.
TD rules say you have to go with the posted mortgage rate for a non-arm’s length mortgage, but there’s still some manoeuvring room to bump up your rate high enough to make it an attractive investment for your RRSP.
Mr. Tsai said TD will allow you to select mortgage terms of one through 10 years. A five-year fixed rate would have put you at 5.44 per cent as of late this week; extending to six years put you at 5.7 per cent, seven years was at 6.09 per cent and 10 years was pegged at 6.4 per cent.
TD also allows a six-month convertible mortgage, which presents an interesting possibility if you see rates moving higher. You’d get a 4.45-per-cent rate for half a year, with an opportunity to benefit from any rate increases that happen between now and then.
But is it a wise investment?
