Inaya Mclaughlin
It is possible to hold a mortgage in your Registered Retirement Savings Plan (RRSP) in Canada, but it is not a commonly used strategy. This is because of the high fees and costs associated with setting up a non-arm's length mortgage, as well as the risk of overexposure to a single asset. The process also involves a lot of paperwork and income verification requirements, and finding a financial institution willing to set up the arrangement can be difficult. However, holding a mortgage in an RRSP can be appealing to younger Canadians and anyone looking for higher-yielding investments.
Characteristics and Values of putting a mortgage in an RRSP
| Characteristics | Values |
|---|---|
| Tax rules | Allow homeowners to hold their mortgage in a registered plan if certain conditions are met |
| Tax rules for first-time home buyers | Can pull from savings in registered accounts to fund their down payment |
| Who it appeals to | Younger Canadians, anyone looking for higher-yielding investments in a low-yield world, people with a conservative risk tolerance, people with a large RRSP |
| Who it may not appeal to | People with a small RRSP, people with a substantial RRSP but a small mortgage |
| Advantages | You can pay yourself a higher rate on the mortgage than you may have earned on the short-term income and cash instruments currently in your RRSP, you can make interest payments to yourself, not the bank |
| Disadvantages | Set-up costs and ongoing fees can outweigh the benefits, it can be difficult to find a financial institution that will set this up, you may be earning a higher return within your RRSP than the interest you are paying on your mortgage, you will forgo years of compounded returns on the money you have withdrawn |
| Fees | Typical mortgage set-up fees ($200-$250), annual trustee fees for holding a self-directed RRSP ($100-$150), legal fees, mortgage insurance premium (0.6% to 4.0% of the amount of the mortgage) |
| Administration | The mortgage must be administered by an approved lender under the National Housing Act, the mortgage must be insured either by the Canada Mortgage and Housing Corporation (CMHC) or by a private insurer of mortgages |
What You'll Learn
The pros of putting your mortgage in your RRSP
While it is technically possible to hold a mortgage in your RRSP, it is not a straightforward process and there are several factors to consider. Here are some pros of putting your mortgage in your RRSP:
Higher Rate of Return
You can pay yourself a higher rate on the mortgage through your RRSP than you may be able to earn on short-term income and cash instruments. This is because the mortgage usually replaces the fixed-income portion of the RRSP portfolio, resulting in a higher rate of return than bonds or guaranteed investment certificates.
Tax Benefits
An RRSP loan can help you lower your taxable income and save on taxes. Contributing to your RRSP gives you a tax deduction, and when you eventually withdraw the funds in your retirement years, you will hopefully be in a lower tax bracket, reducing the overall amount of tax you pay over your lifetime.
Flexible Limits and Terms
Many financial institutions allow you to borrow up to $50,000 with flexible terms, typically between one and ten years. This flexibility allows you to use the funds for the current year or to make up for missed contributions from previous years.
Deferred Repayment
Some RRSP loans offer a grace period before repayment starts, typically around 90 days. This gives you time to receive your tax refund and apply it towards repaying the loan.
Investment Diversification
Holding a mortgage within an RRSP can be part of a diversified investment portfolio. While rental real estate has its risks, it can provide a comparable return to a balanced investment portfolio if real estate prices rise modestly.
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The cons of putting your mortgage in your RRSP
While it is technically possible to put your mortgage in your RRSP, it may not be the best financial strategy for most people. Here are some of the cons of putting your mortgage in your RRSP:
High Costs and Fees: There are significant set-up costs and ongoing fees associated with holding a mortgage in an RRSP. These include mortgage set-up fees, annual trustee fees for a self-directed RRSP, legal fees, and mortgage insurance, which is required by the National Housing Act. The combined cost of these fees can outweigh the benefits of holding a mortgage in an RRSP.
Tax Implications: Withdrawing money from an RRSP is fully taxable, and the tax rate can be as high as 54%, depending on your income and province or territory of residence. This means that a significant portion of your RRSP funds could be lost to taxes when you withdraw them to pay off your mortgage. Additionally, you don't get a tax deduction for putting money into your RRSP, so you will still have to pay full tax on that amount when you withdraw it.
Limited Financial Institutions: It can be challenging to find a financial institution that is willing to set up a mortgage in an RRSP. Many individuals have reported being turned away by major banks and accounting firms. This lack of availability can make it difficult to even consider this option.
Overpaying Mortgage: By putting your mortgage in your RRSP, you may end up overpaying your mortgage in order to contribute to your RRSP. This is because the interest rate on the mortgage within the RRSP may be higher than what you would pay on a traditional mortgage. As a result, you could be paying more than you need to for your mortgage.
Concentration of Risk: Putting your mortgage in your RRSP can concentrate your risk by putting too many eggs in one basket. While real estate can be a good investment, it is important to diversify your portfolio with other investments in stocks and bonds. By using your RRSP to fund a mortgage or rental property, you are tying up a significant portion of your retirement savings in a single asset class.
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How to put your mortgage in your RRSP
While it is possible to hold a mortgage in your RRSP, it is not a commonly used strategy. This is because of the significant fees associated with setting up a non-arm's length mortgage, as well as the risk of overexposure to a single asset.
If you are considering putting your mortgage in your RRSP, the first step is to find an institution that will allow you to do so. You will need a self-directed RRSP from an institution like Olympia Trust, B2B Bank, Canadian Western Trust, or a handful of other trust companies or banks. It is important to note that your RRSP with your investment advisor or bank is likely not an option.
Once you have found an institution that offers self-directed RRSPs, you will need to undergo the same income verification requirements and approval processes as you would with a regular mortgage. The mortgage must be administered by an approved lender under the National Housing Act, and the mortgage interest rate and other terms and conditions must reflect normal commercial practices.
There are also annual fees for maintaining a self-directed RRSP, as well as annual mortgage administration fees that many financial institutions charge. These fees can be significant, and it is important to carefully consider the financial implications before moving ahead.
In addition, if the mortgage is a "non-arm's length mortgage", it must be insured by the Canada Mortgage and Housing Corporation (CMHC) or a private insurer to protect the lender in case of default. This insurance requirement can be one of the biggest costs associated with holding a mortgage in your RRSP.
Overall, while it is possible to put your mortgage in your RRSP, it is important to carefully consider the costs and benefits before deciding if it is the right decision for you.
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What to consider before putting your mortgage in your RRSP
Holding a mortgage in an RRSP is tempting for many people because it allows them to make interest payments to themselves instead of a bank. However, experts advise careful consideration of the financial implications before moving ahead with it. Here are some key points to consider before putting your mortgage in your RRSP:
Associated Costs: One of the most significant drawbacks of holding a mortgage in an RRSP is the associated set-up costs and ongoing fees. These can include mortgage set-up fees, annual trustee fees for a self-directed RRSP, legal fees, and mortgage insurance. The biggest upfront cost is typically the mortgage insurance premium, which is required to protect the lender in case of default. The premium can range from 0.5% to 2.5% of the mortgage amount, depending on the loan-to-value ratio. Additionally, there are annual mortgage administration fees charged by financial institutions for monitoring and administering the mortgage. These costs can add up and may outweigh the benefits of holding the mortgage in an RRSP.
Financial Circumstances: It's important to evaluate your financial circumstances before deciding to put your mortgage in your RRSP. The strategy of holding a mortgage in an RRSP often appeals to people with small RRSPs and substantial mortgages. However, those who have substantial RRSPs and small mortgages may not need to implement this strategy. Consider whether the money tied up in your RRSP could be invested elsewhere to generate higher returns. Additionally, ensure that you have sufficient funds in your RRSP to cover the entire mortgage amount, as only partial coverage may not be feasible.
Diversification of Investments: Putting your mortgage in your RRSP means a significant portion of your retirement savings is tied to real estate. While real estate can be a good investment, diversifying your portfolio with other assets like stocks and bonds can reduce risk. If you use your RRSP to fund a rental property, consider the potential risks of having a large portion of your savings invested in a single asset class.
Finding a Financial Institution: It can be challenging to find a financial institution that will allow you to hold your mortgage in your RRSP. Most banks, credit unions, or trust companies may not offer this option, and you may need to explore alternative lenders. Ensure that the lender is approved under the National Housing Act and that the mortgage interest rate and terms reflect normal commercial practices.
Impact on Retirement Savings: Using your RRSP to fund a mortgage can impact your retirement savings. Withdrawals from an RRSP are fully taxable, and a significant portion may be lost to taxes, depending on your income and province or territory of residence. Additionally, consider whether using your RRSP for a mortgage aligns with your long-term retirement goals and financial plan.
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Alternatives to putting your mortgage in your RRSP
- Investing in real estate investment trusts (REITs): If you want to invest in real estate using your RRSP funds, you can invest in publicly traded or private real estate investment trusts (REITs). This option provides exposure to the real estate market without the need to hold a mortgage in your RRSP.
- Diversifying your investment portfolio: Instead of putting all your eggs in one basket by investing solely in real estate, consider diversifying your investment portfolio. This could include investing in stocks, bonds, or other asset classes in addition to real estate. By diversifying, you can reduce the risk associated with concentrating your investments in a single asset class.
- Using RRSP funds for other purposes: Rather than using your RRSP funds to purchase a rental property or reduce your mortgage, consider saving for a down payment on a house or investing in your children's education funds. The flexibility of RRSPs allows you to prioritize other financial goals alongside managing your mortgage.
- Taking out a mortgage for investment purposes: If you have a fully paid-for home and available funds in your RRSP, consider taking out a mortgage for investment purposes. For example, you could borrow money from your RRSP to invest in a business franchise. The interest on the borrowed funds may be tax-deductible, making it a tax-efficient strategy.
- Comparing interest rates and investment returns: Before deciding to hold a mortgage in your RRSP, compare the interest rates you would pay on a traditional mortgage with the potential investment returns you could achieve by investing your RRSP funds elsewhere. You may find that borrowing from a bank and investing your RRSP funds at a higher return rate could be a more advantageous strategy.
- Renting out your desired retirement property: If you plan to purchase a property for retirement and are considering using your RRSP to fund it, you may want to explore renting out that property until you retire. This can help generate income to support the additional mortgage payments. However, keep in mind that a home you want to live in may not be the best option for a rental property.
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Frequently asked questions
You can put your mortgage in your RRSP by setting up a "non-arm's length mortgage", which allows you to lend money to yourself from your RRSP. However, it can be difficult to find a financial institution that will set up this arrangement, and there are significant fees and costs associated with it.
One benefit of putting your mortgage in your RRSP is that you can pay yourself a higher rate on the mortgage than you may be able to earn on the short-term income and cash instruments currently in your RRSP. Additionally, if you are using the property to earn rental income, the interest you pay to yourself in your RRSP is tax-deductible on your personal tax return.
There are several drawbacks to putting your mortgage in your RRSP. Firstly, there are significant set-up costs and ongoing fees associated with holding a mortgage in your RRSP, including mortgage insurance, which can be the biggest cost. Additionally, you may be exposing yourself to a single asset, as you won't have exposure to stocks and bonds and other asset classes.
Putting your mortgage in your RRSP may not be the best financial strategy for everyone. It is important to carefully consider the financial implications and compare the rate of return on the mortgage, taking into account the one-time and annual costs, to the rate of return your alternative investments would yield. You should also consider the risk of putting too many eggs in one basket and ensure you have a diversified portfolio.
Yes, one alternative is to accelerate your mortgage payments by an additional and affordable amount, which is applied directly to the principal, reducing the amortization period. Another option is to take out a mortgage for investment purposes, as the interest on these loans is fully tax-deductible.
