Should you hold your mortgage in RRSP?

National Post

2005-02-19


GICs, bonds, income trusts, stocks, mutual funds -- Canadian investors today
have myriad choices when deciding how their RRSP contributions should be
invested. There is one option that may seem ideal -- why not put your own
mortgage into your RRSP, in essence paying yourself instead of the bank? While
at first glance this may seem ideal, investing in your own mortgage deserves a
closer look to determine whether it actually makes good financial sense.

A self-directed RRSP can invest in a mortgage on either commercial or
residential Canadian real estate. If you, or someone related to you, personally
owns the property being mortgaged (i.e. your own home), your mortgage is
referred to as a "non-arm's length mortgage." Such a mortgage must be
administered by an approved lender under the National Housing Act (which
includes most financial institutions). The mortgage interest rate and other
terms and conditions must reflect normal commercial practices.

In addition, the mortgage must be insured either by the Canada Mortgage and
Housing Corporation (CMHC) or by a private insurer of mortgages (such as GE
Capital Insurance Canada). The mortgage insurance requirement ensures that in
the event you default on your mortgage, your retirement savings will still be
protected.

The main advantage of putting your mortgage in your RRSP is that you can pay
yourself, through your RRSP, a higher rate on the mortgage than you may have
been able to earn on other low-risk, fixed-income type investments, such as
GICs.

Perhaps the biggest drawback is the cost associated with putting your
mortgage into an RRSP. There are the typical one-time mortgage expenses, which
include set-up, appraisal and legal fees; however, the biggest up-front cost is
the mortgage insurance premium, which can range between 0.5% and 3.25% of the
amount of the mortgage. The amount of the fee depends on the loan-to-value ratio
of the mortgage and is calculated on the total amount of the mortgage on the
property, regardless of the amount held within your RRSP.

In addition, there may be annual fees for maintaining a self-directed RRSP,
as well as the annual mortgage administration charge that many financial
institutions charge as they continue to monitor and administer the mortgage on
an annual basis.

In trying to decide whether or not this is a good strategy, you should
compare the rate of return on the mortgage, taking into account the one-time and
annual costs associated with holding the mortgage, to the rate of return on on
an alternative investment -- say a mortgage fund or a bond fund with exposure to
mortgage-backed securities (whose performance are tied to the Canadian
residential housing market).

Finally, a word of caution. Just because your RRSP is the lender doesn't mean
you can skip the odd payment or two. If you are unable, for any reason, to make
your monthly mortgage payment, the financial institution will generally take
action on your behalf and place the mortgage into default. The institution will
then attempt to collect the proceeds upon a power-of-sale of your property or,
if the sale price is insufficient, from the mortgage insurance. In other words,
holding a mortgage in an RRSP does not get you off the hook in the case of
default.