Normally the sequence of reactions to the discovery that you can hold your own mortgage inside your RRSP (and essentially pay yourself interest instead of the bank) goes from tremendous excitement to indifference (after some serious number crunching anyways).
To cut to the chase: YES – you can hold your own mortgage inside your RRSP. The interest that you were paying the bank can instead be going to your RRSP. But don’t confuse the “badge of honour” of crafting a complex financial strategy get in the way of a true financial analysis. I would say that this strategy (like many) has a real sweet spot in terms of who it is right for. Let’s find out why…
HOW IT WORKS
First off, you need to have more money inside your RRSP than is outstanding on your mortgage (well, technically you can setup a mortgage sharing strategy with your bank – but that is beyond the scope of this discussion for now). What you are doing is essentially turning your RRSP into “the bank”.
Instead of the bank loaning you funds: your RRSP is loaning you funds.
Consider that the interest rate you charge yourself is going to be the rate of return for your RRSP portfolio. (Or at least for the portion of your RRSP that holds your mortgage). You will make your mortgage payments to your RRSP instead of to the bank. It may be this point that makes most people stand up and take notice – more so for the fact that if they have to pay interest, they would rather pay it to themselves.
You’ll have some costs to set it all up of course. Your financial institution will charge around $300 as a one time setup fee, a trustee and mortgage administration fee (the same financial institution normally acts as the mortgage trustee) of about $175 and self-directed RRSP fee of $60-$125 also applies (but you were probably paying that anyways for your self-directed RRSP). Finally, there may be some legal costs associated which can take your total start up costs to the $1,000 range.
You’ll also have to follow some rules. You cannot just arbitrarily charge yourself a low rate of interest to save on interest payments, nor can you charge yourself a high rate of interest to increase the rate of return on your RRSP.
You wouldn’t want to charge yourself a LOW interest rate, because that would be offset by sacrificing RRSP growth.
You wouldn’t want to charge yourself a HIGH interest rate, since… well, you would be charging yourself a high interest rate to borrow money from yourself. So even though your RRSP would be growing faster, you would by paying more towards interest payments on your mortgage.
But the decision as to what rate of interest to charge yourself is somewhat moot, because one of the conditions of holding your own mortgage inside your RRSP is that you charge yourself the going market rate. Hence, the posted mortgage rates of all the Schedule I banks might be all that you could reasonably use anyways.
The main advantage is that you know that the portion of your RRSP that holds your mortgage will have a very safe and reliable rate of return equivalent to the posted mortgage rates – this can be higher than typical bonds and GIC’s. I suppose another advantage is that you have the benefit of paying interest to YOURSELF AS OPPOSED TO A BANK – but that might only serve to make you feel like you are not contributing to the gluttony of our venerable financial institutions more than anything else.
Well certainly there are the start up fees and extra annual administration costs. These alone may require that the total amount of your RRSP used for this strategy should be north of about $30,000 before you would even consider the strategy – otherwise these costs may outweigh the overall benefits.
There is also the requirement that if you invest in a “non-arm’s length” mortgage (meaning you or someone related to you owns the property that is being mortgaged), then you are required to purchase mortgage default insurance (from CMHC or GE Capital Insurance Canada). Normally, you don’t need mortgage-default insurance when you have a loan-to-value ratio of 80% or lower, but in this case, you will need to get it – and the lowest you can expect to pay is a premium of 0.50% of the total mortgage amount (for loan-to-value ratios up to 65%).
However, consider that this is actually a good investment as if you default on your mortgage, the insurance will serve to protect your retirement savings!
Speaking of defaulting on payments – you may be thinking that since you are lending yourself money you could be lenient on yourself since it is YOUR money. Well, remember that mortgage trustee and administration fee you are paying? The financial institution will act in the best interest of the lender (your RRSP) and not “you” per se. As such, they monitor the mortgage payments and if you miss them and/or default, they have the option of forcing a power of sale of your own house in order to protect your RRSP! So in short: you cannot skip payments.
I have heard many people indicate that when the interest rate environment is lower, this strategy becomes less attractive. I would argue that the current interest rate environment moves almost in lock-step with current mortgage rates, hence if you are looking to use this to replace only the fixed income portion of your RRSP – it doesn’t really matter what the current interest rate environment is. However, if you do decide that you will hold your mortgage inside your RRSP and it represents the majority of your RRSP holding – then, yes – it would make more sense when interest rates are higher – especially if you are violating your asset allocation profile in order to engage in this strategy.
So if you’ll remember, I mentioned that there was a sweet spot as to who this strategy is good for. I would argue that the ideal candidate would look something like the following description:
A person who is probably in their 40’s or 50’s and has about $50,000 to $100,000 of a balance on their mortgage.
In addition, they have around $150,000 to $500,000 value in their RRSP. The reason for this “spread” is that if you were to only have enough in your RRSP to hold the mortgage, you are restricting your RRSP investment portfolio to a 100% fixed income investment – which may not be in line with your risk tolerance – hence you could be giving up long term growth. Instead, if you are supposed to have a basic asset allocation of 75% equities and 25% fixed income – you could use 25% of your RRSP for holding the mortgage and the rest to diversify and invest in equities appropriately.
Remember – consult a financial advisor with experience in setting these up if you want an analysis done on your own situation.