Many Canadians may not be aware of it as an investment option, but holding a mortgage in your RRSP can be a way to generate consistency and stability during periods of fluctuating equity markets and low fixed income returns.
“Most people just don’t know about this option,” says Dave Ablett, director of tax and retirement planning with Investors Group Inc. “It is definitely a niche product for certain people.”
In order to set up a mortgage you need to have a self-directed RRSP and a sizable amount of money for it, perhaps $100,000 or more.
The mortgage does not have to be at “arm’s length” with a third party who is not related to you by blood, marriage or adoption. However, if it is not at arm’s length then the following conditions must apply in order for it to be a “qualified investment” for the RRSP.
The mortgage must be administered by an approved lender under the National Housing Act, the mortgage interest rate and other terms must reflect normal commercial practice, and the mortgage must be insured by Canada Mortgage and Housing Corp. of a private mortgage insurer.
Essentially you set up a mortgage just like you would at a bank or financial institution, but instead of making payments to them, payments are made to you and you get to keep any interest. Because it is considered a fixed income investment, it can only charge the going interest rate at the time.
“You really need to have a fairly large mortgage to make it worthwhile,” says Patricia Lovett-Reid, TV host and CTV senior financial commentator. “The real issue is the fees associated with setting it up and administrating it.”
To set up a mortgage there is a one-time fee of about $300, a one-time legal fee of about $500, an administration fee of between $100 to $200, a fee of $125 for a self-directed RRSP, and an appraisal fee. If the down payment on the property is less than 25 per cent of the value of the property, you will need mortgage insurance, which can run anywhere from one to two per cent of the mortgage a year – $4,000 on a $200,000 mortgage.
“You’ve got to consider the expenses very carefully,” Ablett says.
There are three situations where a person could put a mortgage on a home inside a self-directed RRSP – when the individual currently has a first mortgage on the home, the individual has a large RRSP and wants funds to purchase a new home, and the individual does not have a mortgage on a home but wants to remove cash from an RRSP on a tax-free basis for home renovations or for investment purposes without jeopardizing RRSP investment growth. The funds in the RRSP are exchanged for a mortgage of the same value and are paid out on a tax-free basis. The RRSP now holds the mortgage on the home and the RRSP owner is obligated to make the principal and interest payments to the RRSP.
There are advantages and disadvantages to a mortgage in an RRSP.
On the benefits side all mortgage interest goes to you. The going mortgage rates tend to be higher than Guaranteed Investment Certificate (GIC) and many bond rates.
If you are refinancing your mortgage for investment purposes, the costs to set it up as well as the mortgage interest are expenses that can be deductible from the investment income. And interest payments don’t count as RRSP contributions.
The disadvantages are the high fees, the large RRSP holdings requirement, the possibility of earning more with other investments and the possible sacrificing of diversification in your portfolio.
“You want to be sure that you don’t have all your RRSP in a mortgage, which is fixed income,” says Lovett-Reid.
Mortgage RRSPs are a lot more popular when interest rates are high and during periods when equity markets are extremely volatile and when you don’t get much return on traditional fixed income investments.
“We had a lot more inquiries about them 10 years ago when interest rates were a lot higher,” says Ablett. “It’s a niche product for people with sufficient RRSPs who are looking for predictable rates of return.”