Taking the RRSP path to home ownership
You can use your RRSP to finance your own, or someone else’s, mortgage
Robert, 61, has a large investment portfolio in his registered retirement savings plan (RRSP). He’s very knowledgeable in real estate and has been investing part of his retirement savings in mortgages for the last 20 years. Through a mortgage agent, he learned that a borrower needed $50,000 to pay his property tax arrears, buy a new truck for his business and do some minor repairs to his home.
The borrower was not able to obtain a bank loan because he had not filed his tax returns in several years and had some fairly serious credit issues. But his house was appraised at $275,000, which meant Robert would be lending him less than 20 per cent of its appraised value.
He offered a one year mortgage at 7.5 per cent and charged a $1,000 lender fee, bringing his total return for the term of the loan to a handsome 9.5 per cent. In the meantime the borrower was able to get his taxes up to date and clean up some of his old credit issues. At the end of the year, he repaid Robert the loan plus interest, and was able to secure a replacement mortgage at a much lower rate from a credit union. Everyone walked away happy thanks to a little-known fact: You can improve the overall return on your RRSP by loaning out a portion of it to finance your own mortgage or someone else’s.
“An option for RRSP owners is to invest in a mortgage granted at arm’s length to a third party,” says James Robinson, a mortgage agent and owner of a Dominion Lending Centres franchise in Toronto. Robinson helped Robert, who was a client, with his loan.
First you will need to have enough assets in your RRSP to convert into cash, and you will need a self-directed RRSP that gives you more investment freedom and control. Some RRSP accounts only allow for investing in mutual funds and GICs.
Third-party mortgages like the one described above tend to be higher risk loans to individuals who cannot qualify for financing from traditional channels such as banks and credit unions. Higher risk means much higher rates of interest charged by private lenders compared to institutional lenders.
Rates and fees vary depending on circumstances, including the type of property being secured, the income and credit history of the borrower and the loan-to-value ratio (which is the value of the mortgage compared to the property’s appraised value).
Typically, private first mortgages range from 6 to 10 per cent, second mortgages 8 to 14 per cent.
For the investor, the benefit is a much higher rate of return compared to more traditional interestbearing investments such as GICs.
But this needs to be weighed against the risk of this type of lending.
“Borrowers who cannot qualify for an institutional mortgage due to income or credit challenges are more likely to default on payments, which could result in the investor losing money,” Robinson says.
“A good mortgage broker will ensure the facts about the borrower, and property being secured, are fully disclosed to allow the investor to make an informed decision.”
Investors who want to invest RRSP money in third-party mortgages can also speak to a mortgage investment corporation (MIC), which is a professionally run company that pools money from investors and lends it out to individual borrowers.
A lawyer is needed to ensure that the security is registered properly and in the event of a default that the legal process for foreclose or power of sale is handled quickly and efficiently.
The other option to consider is to use your RRSP to finance the purchase of your own home or a rental property.
But it really only makes sense if your RRSP is invested in fixed-income securities like GICs paying a lower rate of interest than a mortgage of a similar length would charge. Under these circumstances you can eliminate the spread or profit margin a bank makes in lending you a mortgage, by borrowing from yourself and repaying yourself.
For example, if you purchase a home for $500,000 and need a $400,000 mortgage, it might be advantageous to borrow money from your RRSP if it is invested in GICs earning 1.75 per cent annually. At the current rate of 2.75 per cent for a five-year fixed-rate mortgage, rather than paying the bank 2.75 per cent, you pay your RRSP thereby earning a higher return, while paying the same rate of interest on your mortgage.
Under Canadian law you are required to purchase default insurance to protect your RRSP from losing money if you default on your mortgage.
This insurance is available from Canada Mortgage and Housing Corporation and private insurers.
Recent changes in mortgage rules have narrowed the definition of eligible properties under this program, including a requirement that the home being purchased is worth less than $1 million.
“In my 29-year career in the mortgage industry, I have only had half a dozen clients even ask about this program, and only a couple that decided to proceed,” Robinson says.
James Robinson, mortgage agent with Dominion Lending Centres, has seen only half a dozen clients inquire about using an RSP to finance a mortgage.