Many people would like to take their monthly mortgage payment and give it to themselves instead of the bank. Sounds too good to be true? It depends…
Instead of paying principal and interest to a bank, you could pay that principal and interest to your RRSP. In effect, your RRSP becomes “the bank”. That means there must be enough money already in your RRSP that can be lent to you in the form of a mortgage (secured by your house), and you would have to make the repayments to your RRSP over time.
For example, let’s say your RRSP has a value of $500,000 and you have an outstanding balance on your mortgage of $200,000. You can arrange for your self-directed RRSP to lend you $200,000 which must be paid back over time with all the same terms as a regular mortgage.
There are costs involved in setting this up: an initial setup fee from your financial institution up to about $300; legal fees which can be $500 or more on a one-time basis; a trustee and mortgage administration fee of around $100 to $200 per year; CMHC insurance premiums of at least 0.5% of the principal; and your usual self-directed RRSP annual account administration fee which is usually around $125 per year. This can all add up to $1500 or more up front and about $250 per year thereafter.
Figuring out your rate of return on this strategy is not so simple as assuming it is the rate of interest you decide to charge yourself. We’ve all seen the calculators that show us over the lifetime of a mortgage we can end up shelling out almost as much interest as the original principal, if not more in some cases. For example, a $200,000 mortgage with a fixed interest rate of 5% over a 25 year amortization schedule yields a cumulative interest charge of about $150,000. In your RRSP’s case, the initial principal of $200,000 turns into $350,000 over 25 years. That in and of itself equates to a rate of return of 2.26% since the amount upon which the interest is being charged is declining over time, but what needs to be kept in mind is that with every monthly payment, your RRSP now has that payment amount freed up to be invested elsewhere. Perhaps you can use it to dollar cost average back into equities over time. Assuming the markets revert to their long term means, that will increase the rate of return on the overall strategy.
Some final notes: mortgage payments to your RRSP are not RRSP contributions and do not generate tax savings; you’ll have to pay CMHC insurance premiums so that your RRSP is protected in case you default on your payments which are monitored by the trustee (remember the trustee fee you are paying?); you should treat the strategy as a fixed income investment when figuring out your overall asset mix; and never engage in a strategy you don’t fully understand.
Being your own bank sounds appealing, but don’t forget to perform a bank-like application on yourself – not everyone could be their own best client.
I was running some numbers on this.
The big issue I see is that you’re getting double-taxed on the mortgage payments, since those will be eventually taxed when those funds are withdrawn from the RRSP.
For example:
$100,000 in RRSP turned into a mortgage, with 5% rate/25-yr amortization
After 25 years of paying back into the RRSP every month in *after-tax dollars* (there are no tax credits, since these are not contributions), that is almost $75,000 in interest paid into the RRSP.
If someone had a 40% income tax rate, that $75,000 would trigger another $30,000 in tax!
If you instead just went for a discounted 3% mortgage from a bank (instead of a 5% mortgage from your RRSP), you’d pay only $42,000 in interest over the 25 years ($33,000 less). Plus, you’d have a couple hundred bucks extra each month in cash flow, since the payments would be lower.
So, to recap, for the $100,000:
$75,000 paid in interest and moved into your own RRSP, which is taxed an extra $30,000 to the government on withdrawal from the RRSP.
vs.
$42,000 in interest to a bank.
So, over 25 years, you’re either losing $30k in taxes, or $42k in interest payments… ignoring all fees, and you’re $12k ahead with this $100,000 mortgage example.
But, after the $1,000-$2,000 to set up and insure the RRSP mortgage, and $250/yr to run it ($6,250 over 25 years), you’re maybe a couple grand ahead vs. simply shopping for the lower rate mortgage and paying the interest to the bank.
Is this really all worth it? Is saving $4,000-$5,000 over 25 years (less than $200/yr) worth this kind of hassle???