How to loan an RRSP mortgage

If you want tax-deductible debt and a steady stream of returns

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by

From the November 2016 issue of the magazine.

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RRSP mortgage

Former federal government employee Tony Miller earns a steady return by loaning out his RRSP money. (Jessica Deeks)

Born and raised in the east-end Orleans area of Ottawa, Tony Miller married an amazing woman, fathered two wonderful children and went to work for the federal government. But when he lost his job in 2013, he was faced with a predicament.

“I had a bit of money to play with from my severance package, but didn’t want to stick it in my RRSP,” says Miller. “I just didn’t like the returns I was getting on the mutual funds and stocks I held.” At the same time he was retraining to become a realtor and liked the idea of property investments, but didn’t relish the idea of getting involved in property management and tenant issues. “I wanted a less hands-on property investment.” So, Miller decided to imitate the banks and start lending out his own RRSP money in the form of a private loan. “It gave me much better returns,” says Miller, who calculates the annualized net return on his private loans at 10%. (Just like the banks, Miller requires full financials from potential borrowers, including credit scores and income verification.)

Miller isn’t the only one. Private lending has grown considerably due, in part, to tighter lending restrictions. According to the federal Department of Finance, the number of private lenders in the nation’s $1.4-trillion mortgage market jumped from 6.7% in 2007 to almost 13% in 2015. Comprised of everyday Canadians, publicly traded companies, investor groups and retirees, these lenders provide options to those turned down by regular banks.

Dangers of private lending

But private lending comes with risk. Also known as Joe Schmo- or shadow-lending, because there is little oversight in this market, private lending comes in many forms—and they’re not all equal. For instance, there are companies that specialize in securitizing the mortgages (a way of turning an illiquid asset into an investable security), as well as groups that focus on packaging cash from hundreds of investors and turning it into developer loans (also known as syndicated mortgages). “These are complex investment vehicles that come with quite a lot of risk,” explains one Toronto-based mortgage broker. There are also products that are often sold by individuals with little or no investment training. These risky private lending investment options are the Canadian equivalent of the U.S. sub-prime market. There are few regulations, lots of money-hungry brokers and aggressive investors chasing returns that are sometimes trumped up. But this doesn’t mean private lending shouldn’t have a strategic place in your financial plan—particularly in the case of RRSP mortgages.

What’s an RRSP mortgage?

Most RRSPs are held by a deposit-taking institution that offers a variety of investment options. But in a self-directed RRSP, investors are free to choose other types of investment products, such as debt instruments. “In self-directed mortgages, you can use the money saved in your RRSP to fund mortgages,” says London, Ont.-based Certified Financial Planner Gerry Hogenhout.

For instance, if you had $100,000 in your RRSP, you could convert this investment into cash (this won’t trigger a tax hit) that you can then loan out (known as a non-arm’s length mortgage)—either to yourself, a family member a friend, or a stranger.

Why would you do this?

The reason for doing this is simple—“because it gives you a steady return,” says Hogenhout. Every loan repayment, including the interest portion, goes back into your RRSP. “Even if fees eat up 1% of your returns, you’re still earning more than what you’d get from GICs and other forms of fixed-income investments,” he explains.

Better still, these mortgage payments don’t count towards your annual RRSP contribution limits while the mortgage interest paid is considered a tax deduction. That means you not only get a tax deduction each year, while getting a steady return in your RRSP, but you can still make annual tax-sheltered contributions that further help to reduce the annual income tax you pay.

How do you do this?

There are strict rules. Any RRSP mortgage must be administered by an approved lender, known as a trustee, under the National Housing Act, and the interest rate you charge, along with all loan conditions, must reflect normal commercial lending practices. At the moment, the posted commercial rate for five-year fixed mortgages hovers around 4.5% (and a 1% reduction, due to fees, still gives you a 3.5% return).

Who should do it

“It’s a good option to consider for those who have large amounts of fixed income and have several hundred thousand dollars in GICs paying a paltry return of 1.5%,” explains Talbot Stevens, author of The Smart Debt Coach. In other words, it’s a strategy that works well for those with good-sized nest eggs who also want more return on the fixed-income portion of their portfolio. “But you have to be willing to put in the effort to do the due diligence,” advises Stevens.

Of course, any advantage offered by an RRSP mortgage should be weighed against the costs and risks involved. In addition to the typical one-time mortgage expenses, most trustees charge annual administration fees and if the mortgage is to you or a family member you also need to pay mortgage-insurance premiums, which typically range from 0.5% to 2.9% of the total mortgage amount (irrespective of how much equity you have in the property). Then there’s the risk. If you lend to family members or to yourself, you need to remember that you can’t be late or miss payments, or you risk foreclosure, initiated by your trustee. If you lend to strangers you take on an entirely different level of risk, one that requires much more due diligence. “No investment comes without risk,” says Miller, “but I don’t lend to people I don’t know.”


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10 comments on “How to loan an RRSP mortgage

  1. which Institutions will do this?

    Reply

    • Olympia Trust can setup these accounts for you, some other institutions used to do it, but there is little money in it for the banks(see MER fees).

      Reply

  2. Hi Can you make some reccomedations on some trusts that handle this kind of thing? Referring to How to loan an RRSP mortgage

    Reply

    • Hey I am currently invested in this, its a great investment!! Also if you invest in 2nd or 3rd mortgages for investment properties you can get returns of 10-20% annually. Olympia Trust out of Calgary can set these accounts up for you.

      Reply

  3. How is this a better investment strategy than buying stocks with a dividend of 3-4%? It seems like a lot of risk to me, and is there any liquidity in this type of investment?

    Reply

    • When you are invested there is not much liquidity, BUT the investment on many levels is less risky than stocks as your money is tied to an actual asset, just make sure you don’t loan out more than 95% LTV to ensure the homeowner still has some skin in the game….

      Reply

    • Haha – seems like a lot of risk to you? The only risk with this investment is if you don’t make your mortgage payment. But you’re right, dividend paying stocks are always guaranteed and never go down….

      Reply

  4. Can this strategy be used with a LIRA?

    Reply

    • Yes!

      Reply

  5. How are you explaining the change in risk aversion? If someone is sitting on $100,000+ RSP is GIC (Badly advised to begin with) they are living in fear of losing money. Now your article is describing a method of having them loan their retirement savings to people who the banks won’t lend money too? Ridiculous, as another commenter posted, just invest in the market you can get better than GIC returns and at reasonlble risk, with plenty of upside.

    Reply

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