BY: JAY BRIJPAUL
Saving for retirement in an RRSP account is one of the few tax benefits remaining for Canadians. Most contributors do not manage their investment portfolios and rely on their financial institutions. Their savings are invested in mutual funds with high management fees associated with it. The high fees reduce the profit and slow the growth of their investments. Another strategy is to invest in an RRSP mortgage where the investor has more control.
An RRSP mortgage is like a bank mortgage where the bank lends the money and holds the property as security. In this situation, the investor holds the mortgage on a specific property. This is called a private mortgage and the terms and conditions are negotiated by both the lender and the borrower. Since it is a private mortgage, investors must do their own due diligence.
First investors must find a financial institution that would allow this. Most financial institutions prefer to give a mortgage and to invest their clients RRSP. With an RRSP mortgage, the banks are losing profits from both sides. A few financial institutions such as Canadian Western Trust, Olympia Trust, and TD Waterhouse offer this service for a fee.
The first step is to open a self-directed RRSP with the company and transfer all the existing RRSP into it. This may take some time because the RRSP holder must liquidate the current portfolios and pool the money into one account. There are no tax penalties because the investor is simply transferring funds from one account to another.
Financial institutions will act as a trustee for the RRSP mortgages. The process of qualifying is the same as if the borrower is applying for a mortgage where income varification, credit search, and approval are required. To set up an RRSP mortgage, the cost involved is administrative cost, CMHC fees, and appraisal fees. The original set up fees can be a few thousand dollars and the monitoring costs a few hundred dollars every year.
Once the RRSP mortgage is set up, it operates just like a regular mortgage where the borrower makes regular monthly payments to the RRSP. The cash accumulated can be reinvested. If there is a default, the trustee is responsible to sell the property under power of sale.
With RRSP mortgages, the interest rate is the posted rate and not the discounted rate. As such, you will be paying a higher interest on your mortgage payment and a higher interest income will be going to the RRSP. There is a downside, however; let’s assume that you borrow from your RRSP at 4% and your rate of return is 6% then the spread is only 2%. However, if you borrow from the banks at a discounted rate of 3% and invest at 6% then the spread or profit will be greater. It is not a vehicle to use for principal residence but an RRSP mortgage can be beneficial when purchasing a rental property. The higher interest paid to the RRSP is a tax-deductible expense against personal income and higher interest earnings for the RRSP holder.
Most RRSP mortgages are second mortgages with returns between 12% to 14 % plus finder’s fees and lawyer fees. As a private lender, the investor must ensure that the investment is sound. It’s best to make sure that the borrower has about 15% of their own money invested in the property. This is called loan to value ratio or LTV. The higher the LTV, the greater the risk. For novice investors, it is advisable to seek expert advice from a mortgage broker, real estate broker and a lawyer.
RRSP mortgages are an innovative strategy where investors have full control of their investment portfolios and can avoid high mutual fund fees. With RRSP mortgages, the portfolio should be substantial, at least $50,000 and above to work.