The article “Banks’ Dirty Little Secret: You Can Hold Your Mortgage In Your RRSP — But Is It Worth The Trouble?” was originally published on Financial Post on February 27, 2017.
There are a lot of reasons why holding your mortgage in your RRSP is appealing. And there are a lot of people who could be candidates for the strategy. But I am going to let you in on a dirty little secret — the financial industry does not want you to know about holding your mortgage in your RRSP in the first place.
Many investors are still affected by the global financial crisis nearly ten years later. It was the collapse of the subprime mortgage market in the United States in 2007 that began the domino effect. It is hard to believe a decade has passed.
Since then, stock and real estate markets have had a profound emotional impact on investing for Gen Xers and Millennials. Canadians born after the baby boom that ended in 1964 were entering their 40s when the global financial crisis ensued. This is an age when many people are moving into larger, more expensive homes and simultaneously ramping up their retirement savings.
Younger generations of Canadians have therefore experienced a period when rising real estate is taking an ever larger share of their family budget, often at the expense of traditional investing. It has also been a period during which many people have felt that real estate has nowhere to go but up and is the best investment around.
This preference for real estate over stocks is further reinforced by the fear instilled by the 35 per cent drop in Canadian stocks experienced by the Toronto Stock Exchange in 2008. According to a recent poll by Mackenzie Investments, “younger Canadians are significantly more likely to have negative feelings around RRSP season, while those in the 55+ age group appear more positive.”
Younger Canadians certainly have not had the same hesitation regarding real estate and mortgages, continuing to push real estate prices to all-time highs and doing so on the back of more and more debt.
So holding your mortgage in your RRSP can be appealing to younger Canadians, as well as anyone looking for higher yielding investments in a low yield world.
If someone wants to hold their mortgage in their RRSP, the first step is to find an institution that will allow you to do so. Your RRSP with your investment adviser or your bank is likely not an option. You will need a self-directed RRSP from an institution like Olympia Trust, B2B Bank, Canadian Western Trust or a handful of other trust companies or banks.
You will have to undergo the same income verification requirements and approval processes as you would with a regular mortgage. So holding your mortgage in your RRSP is not a way to borrow more money than you would otherwise be able to borrow conventionally.
The applicable interest rate will be the posted rate — not the discounted rate that most of us are accustomed to paying. This means more interest on your mortgage payments, but that is offset by high interest income for your RRSP.
There are fees involved, including appraisal fees, administrative charges, self-directed RRSP fees, mortgage insurance and so on. Set-up fees could be a couple of thousand dollars and ongoing costs could be a couple of hundred dollars each year.
Once set up, you make regular payments to your RRSP the same way you would otherwise do to the bank. The mortgage payments accumulate in cash in your RRSP and can then be invested into other investments. The principal and interest calculations are the same as with any regular mortgage.
Of note is that payments are not considered RRSP contributions. And just like your regular mortgage, you cannot miss payments. It does not matter that you are both the lender and the borrower. The trustee that holds your mortgage is responsible for initiating foreclosure if you do not keep up.
Much of the advice I have come across about holding your mortgage in your RRSP suggests that you need to have a large RRSP or a small mortgage to consider the strategy. That is not true, as the Canada Revenue Agency (CRA) states that “there is no income tax requirement that such mortgages be a first mortgage or (even) a residential mortgage.”
On that basis, you can hold a portion of your overall mortgage debt on a property in your RRSP and another portion as a regular mortgage with a conventional lender. That said, the cost and time to set up a small mortgage in your RRSP may not be worth it.
It is also interesting to note that the CRA does not prevent you from holding a commercial property mortgage in your RRSP or even a rental property mortgage. These mortgages would be even more appealing mortgages to hold in your RRSP because if you are using these properties to earn rental income, the interest you are paying — to yourself in your RRSP — is tax deductible on your personal tax return. Furthermore, the interest rate on these mortgages may be higher than the interest rate on a residential 1st mortgage, meaning higher income for your RRSP and higher tax deductions for you personally.
So back to my comment about the financial industry not wanting you to know about holding your mortgage in your RRSP. Most industries — the financial industry perhaps more than any other — have biases. We live in a capitalist society and the financial industry benefits when you borrow your mortgage money from them and invest your RRSP money with them as well. It gives them two sources of profit, as opposed to you cutting them out and holding your mortgage in your RRSP.
But this is a great case of what sounds like a great way to stick it to the establishment that sounds good in theory, but probably is not good in practice.
Consider this: if you hold your mortgage in your RRSP, you might be borrowing at 5 per cent and investing at 5 per cent (the posted rate). But if you can instead get a regular mortgage, borrow at 2.5 per cent and ideally invest at 3 per cent, 5 per cent, or even 7 per cent, you are going to be much better off in the long run because you will make money on the spread.
On that basis, despite the appeal and despite the large number of Canadians who could hold their mortgage in their RRSP — I would think twice.
Despite the large number of Canadians who could hold their mortgage in their RRSP — I would think twice
Those most likely to benefit would be ultra-conservative investors who are unlikely to take on stock market risk. Someone with a tax-deductible mortgage on a rental property, especially if they are in a high tax bracket, is another potential candidate.
But I would generally shy away from the strategy and instead use the bank as your partner instead of your enemy. Take their cheap money as a mortgage and do your best to invest your RRSP in a diversified portfolio.
If you really want to hold a mortgage in your RRSP, I would rather see you own someone else’s mortgage and ideally as a diversified pool of mortgages like a Mortgage Investment Corporation (MIC). Better yet, consider a diversified mix of stocks and bonds at a reasonable fee that are suited to your personal risk tolerance.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.