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Gail Bebee is a Personal Finance Author and Speaker. (Tory Zimmerman/The Globe and Mail)
Gail Bebee is a Personal Finance Author and Speaker. (Tory Zimmerman/The Globe and Mail)

New to direct investing? Part 9

Ways you can invest in mortgages Add to ...

Gail Bebee is the author of No Hype - The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is www.gailbebee.com. This is part nine of a 12-part series for people that are new to investing on their own.

Every day I read stories in the media about the latest home sales figures, where mortgage rates are going, construction starts and so on. What I rarely see are articles on mortgage lending.

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Lending people money to buy real estate seems like a relatively low risk investment since the property is pledged as collateral. Mortgages are a significant business for all the major Canadian banks. This certainly suggests that mortgages are lucrative place to invest. What, then, are the options for a retail investor who wishes to invest in this fixed-income product?

For first-time home buyers with registered retirement savings plans (RRSP), lending yourself money from your RRSP to buy your first house is one way to become a mortgage lender. The federal government's Home Buyers' Plan lets Canadian residents borrow up to $25,000 from their RRSP to buy a first home. You must start repayments the second year after the year you withdrew the money and you have up to 15 years to repay your RRSP. For complete details, read the fine print at the Canada Revenue Agency website. Note that you are foregoing tax-deferred growth on the money you borrowed from your RRSP. But, if you cannot afford a house otherwise, I think the Home Buyers' Plan is worth this cost.



New to direct investing? The series

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With over 10,000 mutual funds in Canada, it's not surprising that there are funds which invest in commercial, industrial and/or residential mortgages and mortgage-backed securities. These funds are part of the Canadian short-term, fixed-income fund class and should have the word mortgage in their name.

Once you've found a mortgage fund of interest, do some research so you understand what you are buying, especially the quality of the underlying mortgages. Look for funds with low management fees, an important success factor for fixed-income investments. Mortgage fund distributions are taxed as income, so they may be better candidates for an RRSP or TFSA.

Here are some mortgage funds picked from a GlobeFund Fund filter (no load; a management expense ratio (MER) of less than 2 per cent; a Globe 5-star rating of 2 or more) of the aforementioned fund class:

MER

1 Yr Return, %

3 Yr Return, %

ACM Commercial Mortgage (private mutual fund)

0.97

9.64

-

HSBC Mortgage - I Series

1.48

6.14

4.44

National Bank Mortgage

1.67

4.82

3.98

Scotia Mortgage Income

1.20

5.66

4.17

TD Mortgage

1.73

7.21

4.80

Toronto Stock Exchange-listed companies include income trusts in the mortgage lending business. Firm Capital Mortgage Investment Trust is a non-bank lender in residential and commercial real estate niche markets that are under-serviced by the big banks. It is currently yielding about 9 per cent. Not too shabby, you say? Yes, but there are risks. It focuses on higher risk mortgages, things like bridge financing, construction lending and short-term mortgages. And then there is the question of what will happen to the unit price and distributions in 2011 when income trusts start to pay corporate tax. Another trust in the mortgage business is First National Financial , currently yielding 7.8 per cent.

If you take a pass on income trusts, you might consider investing in TSX-listed companies in the mortgage business. Home Capital is a company that caters to consumers who do not meet big bank credit requirements. A significant portion of their business is residential mortgages for these higher risk clients. It yields a 1.6-per-cent dividend. Equitable Group also underwrites higher risk residential mortgages and pays a 1.9-per-cent dividend. These are definitely higher risk investments and both stocks are near their 52-week highs, so proceed cautiously.

Mortgage investment corporations (MICs) are companies created under the Income Tax Act to enable people to invest in a pool of residential and other mortgages. A MIC pays 100 per cent of its annual net income to shareholders in the form of dividends which are taxed as interest income. MICs often underwrite higher risk mortgages, but the rewards are attractive for a fixed-income investment. For example, Fisgard Capital, a B.C.-based MIC, reported that its investors enjoyed a 2008 net cash return of 9.26 per cent. MIC's are typically smaller, private companies. A few trade on the TSX such as MCAN Mortgage , with a current yield of 7.8 per cent, and Timbercreek Mortgage Investment , with a current yield of 8.2 per cent. While MICs do focus on capital preservation and do spread the default risk, thorough due diligence is still essential before investing.

Mortgage investments generate a regular stream of cash, but they are not government bonds. There are risks. The value of your initial investment could vary: the price of mutual funds and exchange-listed trusts and companies do fluctuate. Furthermore, a mortgage company could go bankrupt due to excessive mortgage defaults as we witnessed with the sub-prime mortgage crisis in the U.S. (but not in Canada) over the past two years. However, it is my contention that a carefully selected holding of mortgage investments has a place in the portfolio of many direct investors. I think Canadian banks are on to something.

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