Yahoo Finance How you can hold your mortgage in your RRSP and pay yourself instead of a bank
Most Canadians know they can borrow from their RRSP to buy their first home under the Home Buyer’s Plan, but what they don’t know is they can actually hold a mortgage in their RRSP further down the road.
You can hold a number of different securities in your RRSP, explains Nathan Parkhouse, a certified financial planner at Parkhouse Financial.
“While you cannot hold real estate, (you) can hold a non-arms-length mortgage (or) an arms-length mortgage in your RRSP,” he says.
Essentially, an non-arms-length mortgage is when you lend yourself the money to buy a home (which is not your first home) from your own RRSP.
“The idea would be: say you had $200,000 in your RRSP, instead of investing it in the traditional market sense of stocks, bonds, mutual funds, GICs and cash, you could actually lend the money from your own RRSP,” says Parkhouse. “You become your own banker.”
Naturally, there are rules and fees involved. The mortgage must be fully insured by CMHC, administered by an approved lender – known as a trustee – and you must qualify as you would for a normal mortgage.
“It works based on mortgage rules, you do have to pay principal and interest back to the mortgage, it has to be properly documented, it has to follow the mortgage rules,” says Parkhouse, adding that the strategy works best for Canadians further in their career who’ve built up substantial wealth in their RRSPs.
So why bother?
“This is a classic pay yourself strategy,” says the financial planner. The interest rate you charge yourself just has to be equal to the posted bank rates. So if the discounted five year fixed mortgage rate is 2.5 per cent and the actual posted rate is somewhere in the realm of 4.5 and you lend yourself a five year mortgage at 4.5, you just boosted the return you’re paying yourself, says Parkhouse.
The mortgage payments you’re making don’t count towards your annual RRSP contribution limits, plus the interest you pay is considered a tax deduction. You still end up with your annual tax-sheltered contribution room (less the mortgage interest paid into your RRSP) give you further wiggle-room to reduce your annual income tax.
The downside
“It’s the opportunity cost,” says Parkhouse. “If you have a five or seven-year term and you’re lending yourself five or six per cent – you’re missing out on capital market investing at 10 per cent.”
There are costs involved ranging from appraisal fees and administrative charges to self-directed RRSP fees. These could easily run you up to a couple thousand dollars to set up and $100 dollars or more annually to use this strategy.
Plus, your money isn’t very flexible; you’re locked into a term under the same rules as any mortgage. To get a higher interest rate you have to lock into a longer term.
“It’s a strategy you need to be committed to for the length of the term,” he says.
With the pros and cons in mind, Parkhouse admits using an RRSP to hold a mortgage can be a complicated strategy.
How to do it
The first step is finding a financial planner who specializes in advanced tax strategies.
You’re also going to need the trust wing of a financial institution that can act as trustee for the mortgage on your behalf for your self-directed RRSP. Olympia Trust, B2B Bank, Canadian Western Trust are some of the major players still in this space, says Parkhouse pointing out that the number of banks willing to offer these sorts of non-arms-length mortgages in RRSPs are dwindling.
“There are fewer and fewer institutions that will do it,” he says. “I don’t think the (major) financial institutions really make that much money… they just make an annual admin fee for holding the mortgage.”
And where banks don’t make money, they’re less likely to focus their efforts, says Parkhouse, making it less a secret kept by the banks and more of a headache they’d rather avoid.
“(But) the strategy is sound for the right situation but in the very low interest rate environment we live in, not as many people are doing this,” he says. “When interest rates are much higher, it’s more common.”
