I was a guest on a local talk show last weekend. I fielded
questions that had excellent subject matter and I would like to share one
with you today... the RRSP funded mortgage.
One caller asked:" Is it a good idea to hold your own mortgage within
your RRSP?"
First let me explain the question. There is a mechanism in Canadian
Law that will allow you to invest your own RRSP dollars. This is
called self-administered or self-directed RRSPs. Simply stated, even
though your RRSP funds are with ABC Trust Company, you take the responsibility
of telling them (the Trust Co) where to invest your money. You may
want your RRSP to "buy" Canada Savings Bonds, stocks, or mutual funds.
You advise your Trust Company accordingly, and they will follow your instructions.
You may have accumulated $50,000 in your RRSP. You may also owe
$50,000 to XYZ Bank as a mortgage on your home. You could direct
ABC Trust to use your RRSP funds to pay off XYZ Bank and take the mortgage
for security. In other words, your RRSP is now your mortgage Lender.
As long as the rate of interest is competitive (not ridiculously low),
the mechanism exists to do just that.
Now to answer the question. I do not think it wise to hold your
own mortgage within your RRSP.
If you invest in your own mortgage, it does not constitute an "arm's
length" transaction. In other words, since it is your RRSP that is
lending you money, it(your RRSP) may not have made a sound credit decision.
The Law states that Canada Mortgage & Housing Corporation (CMHC) must
insure this loan against default, whether or not you are in a "High Ratio"
position. Of course, there are insurance premiums to pay!
Secondly, you and your RRSP should be at opposite poles. As a
Consumer, you should want to pay off your mortgage as soon as possible.
As a future retiree, you will want to accumulate as much as possible within
your RRSP. As a Consumer, you should want the best of interest rates,
but your RRSP should want the highest rate possible. The solution
is simple, as a Consumer, go shopping for the best rate available with
a normal lending institution. Have your RRSP fund someone else's
mortgage, at a higher rate. Since this laon is to a stranger, the
loan is now "arm's length", therefore CMHC need not be involved.
We regularly present our Investors with mortgage possibilities that
yield 10-14% and can be considered very safe. As an example, Al wants
to buy a house for his daughter. This unit will be called an investment
property. The daughter will pay rent of $900 per month. Al
works for himself. He has a hard time proving income. He goes
to the Bank to get a mortgage for 90% financing for this new house.
It tells him that since this is an investment property, CMHC will only
finance 85% of the purchase price and charge an insurance premium of 5%
of the mortgage amount (%5500). The Bank added that he must prove
he made $80,000 per year to be approved. There had to be another
way.
We were able to get Al financed by splitting up the deal into two mortgages.
The first mortgage was for 75% of the purchase price, while the second
mortgage was for an additional 15% (90% total financing). For the
second mortgage, the Investor that funded the deal wanted a rate of 14%
because Al could not prove his income. It was cheaper for Al to pay
14% on this mortgage than to pay CMHC $5500 for lender insurance coverage.
The second mortgage Investor is not insured against a loss but to look
at Al's credit history, his assets, and the way he cared for his own house
was security enough. The Investor who funded the deal did so through
his RRSP. He simply filled out the proper papers to tell his RSP
Trustee (one of the big banks) to invest in this "arm's length" second
mortgage. Everybody wins!