Not sure why recently, but I’ve been talking a lot about how to use your RRSPs to invest in mortgages.

Most bankers or stock brokers will probably look at your funny if you ask them about this. This is probably just outside of the limits of their understanding. They will give you the standard answer of “you can only invest in stocks, bonds or mutual funds”. The reason behind this is obvious, this is where THEY make the most money. Investing in a mortgage would give you the power of the bank and make YOU money… inside your RRSP so it’s tax free. Some banks would see this as a threat and tell you it can’t be done.

For the most part, they may be correct as well as only certain institutions allow you to hold a mortgage within your RRSP.  The three that I am aware of or at least are set up to do this and have folks that understand and are willing to assist are, TD Canada Trust, B2B Trust (division of Laurentian Bank) and Olympia Trust. Each it turns out has it’s own strengths and limitations. A simple example is, TD will allow for a mortgage to be registered on a Quebec property even though I am in any other part of Canada. Laurentian, even though they are based in Montreal, wont allow “cross border” mortgages.

Side note: Have I ever mentioned how really different and challenging it is for me to get financing in Quebec? I have done it and continue to do so, but have found that I am part of a very limited set of brokers/agents who can. Proximity is the key and having national lenders is the other. It’s always the first question I ask of new to lenders.  The answer is always no (with a few exceptions). The rules are you have to have some base of operation in Quebec to lend in Quebec. I’m sure there are other hoops as well, but that’s the biggest one.

I digress. Back to RRSPs

So, how is it all done you ask?

Well, technically, thanks to the new legislation in Ontario at least, it has to be done through a mortgage broker/agent. Most provinces are heading this direction (regulating the industry), so look for it in a province near you.

Here’s a typical scenario. We have a property owner who has a first mortgage in good standing. Has run into credit problems for whatever reason. Can’t refinance, but has equity in his home. It will likely take them 2 years to straighten everything out, but meanwhile needs to use the equity to lower his monthly costs, pay off his outstanding credit and get on with life.  In 2 years, should be able to refinance to pay you out.

The house is worth $200K and he has a first for $100K. They need $40K to get caught up on everything. You have $40K plus in your RRSP and agree to register a 2nd mortgage at 12-14% either principal & interest (P&I) or interest only. I prepare the mortgage docs, which include enough detail for you to calculate your risk vs reward and allow you to go out and view the property and/or interview the owner if need be. Most often you will get the bigger picture from the data presented (i.e. appraisal & credit bureau), but some like to add the personal touch.

Once you agree to the mortgage undertaking, we get in touch with your lawyer and he prepares the remaining documents, contacts whichever institution you hold your self-directed RRSP plans with and registers a new 2nd mortgage on title. Your investment is now secured by real estate. It’s not going away anytime soon and it has to have insurance.

The institution collects payments via pre-authorized payments on your behalf and you watch your RRSP grow at 12-14 (or more) percent.

I threw a little twist in there for those that were paying attention. Yes, your funds must be in a self-directed account. How do you know if it is? It’s the proverbial, if you have to ask then likely you don’t have it in the correct account. Believe me you’ll know you have it in a self-directed account as there will be plenty of paper work to fill out and the statements you get from the institution will have it clearly labeled.  There will be some effort to get this done as it is expected you will want to invest this “cash” in some vehicle and not leave it there sitting not earning interest.

Fees. Here’s the really cool part. Who ever borrows the funds pays all the fees and you get to set what your “lender” fees are! You have the option of getting paid these fees inside or outside of the RRSP. You probably want to cover your internal fees (i.e. $250 setup and $150/year maintenance) so that you don’t lose money in your RRSP each time you do this, but that’s up to you to calculate if the interest earned more than covers the fees.

The lender even has to pay for your legal fees. Typically they are deducted from the amount forwarded, but it doesn’t come out of your pocket.

While we’re at it, I also get to charge a broker fee. This is the part I like. If I’m doing my own deal, I can charge a lender fee & broker fee. All perfectly legal.

What has happened in the past is sometimes the amount borrowed is increased to cover these fees, so that the borrower actually gets enough to pay all the bills and isn’t given a new bill on top of everything. So in the scenario above, the loan amount goes to $43K to cover fees.

For first time investors, maker sure you don’t go above 85% loan to value (LTV). Why? Look at the worse case scenario. The borrow stops paying and you personally take the property to power of sale in order to get your investment back. You want a quick sale, thus the price must drop below market to make it attractive to buyers, say 5-10% and you have to pay an agents commission 5-6%. Add up the numbers and that’s 15% off the value and possibly dipping into your investment.

If you have a lot of faith in the borrower or property for whatever reason, you can consider 90% LTV, but for the added risk to you, increase your rate to 14-17%.

Remember this is still less than the 20-30% being charged by the credit card companies and the 3% minimum monthly payments the need to make and it’s only for a couple years until they can refinance the whole thing to a lower rate.