Home sweet RRSPs

How to be a mortgage lender -- to yourself

Deanne Gage 29 May, 2012 | 6:00PM

You may have heard talk of people holding their mortgage in their RRSP. But how does it work and do you qualify to participate?

Let's say you are renewing your mortgage and have $200,000 left. If you go the traditional mortgage route, you would find a lending institution to approve that required mortgage. Then you would make agreed-upon payments at a specific interest rate, amortized over a specific number of years.

If you chose to hold your mortgage in your RRSP instead, it works as follows. You first get this approved by your lending institution through various credit checks. Then, the lending institution would take $200,000 directly from your RRSP and set it up as a mortgage.

You will still be required to make the same mortgage payments to the principal and pay interest. But that interest will be paid back to your RRSP, not a lender, explains Frank DiPietro, director of tax and estate planning for Mackenzie Financial. "It's like your RRSP is acting as your bank and your home is being used as collateral for that loan," he says.

The mortgage rate you charge yourself has to be similar to commercial lending rates but you can use the highest allowable rate available.

Some might find it appealing to pay interest to themselves instead of the bank, DiPietro adds. Others might be attracted by potentially achieving better rates of return in the fixed-income portion of their RRSP portfolio.

"The rate of your return on your mortgage could be greater than just holding a GIC, term deposit or money-market fund in your RRSP," DiPietro explains. "We're in a low-rate environment. This may be an opportunity to get into a mortgage investment which pays 3 or 4%."

But before you say "sign me up," converting an RRSP to a mortgage requires a number of rules and conditions.

Any payments made back to the RRSP are not considered contributions. That's because it's an investment inside the RRSP.

You also need to have enough funds in your RRSP to cover the mortgage. But to ensure diversification, DiPietro goes much further. He recommends that you have much larger RRSP assets, so that only about 25% of your portfolio is invested in your mortgage.

Otherwise, if you only have a $200,000 mortgage and a $200,000 RRSP, converting 100% of those funds to your mortgage is not sound financial planning. "It would leave a client with an improper diversification if your RRSP is only in your mortgage." So, no different than holding 100% of your portfolio in equity funds, for example.

Of course, another alternative is to have only a small mortgage. Let's say you have a $500,000 RRSP but only $50,000 left on your mortgage. Using a small portion of your RRSP for the mortgage may make sense.

What about dividing it up by having a traditional mortgage and a RRSP mortgage? DiPietro says it tends to be an all-or-nothing proposition.

Before setting up a mortgage in your RRSP, you'll want to factor set-up and administrative fees into the equation. "A lot of people don't end up doing it because once they find out the costs, it deters them away," says DiPietro. "You have to ensure the costs are justified and worthwhile."

To start, you must purchase mortgage insurance for as long as the mortgage is held in your RRSP. With a traditional mortgage, if you put down 20% or more toward your mortgage, you can avoid such a cost.

Then there are administrative costs for converting your RRSP into a mortgage. One-time legal fees start at about $500. If your mortgage was at TD Canada Trust, for example, expect to pay $250 to set up the account and another $225 in annual fees to administer the account, notes Farhaneh Haque, director of mortgage advice at TD Canada Trust.

She notes that if you're a couple and you want to split the mortgage between each of your respective RRSPs, count on an extra administrative fee for that setup.

If this is a strategy you're considering, sit down with a financial professional who can help you determine if the pros outweigh the cons.

About Author

Deanne Gage

Deanne Gage  Deanne Gage is a Toronto-based writer who has specialized in personal-finance issues since 1999. A recipient of several journalism awards, including one from the Investment Funds Institute of Canada, she is also a former editor of Advisor's Edge and Advisor.ca. She can be reached at deannegage@gmail.com.