Are Canadians Overlooking
Compounded Returns?

PJ Wade

"Interest compounded semi-annually" -- dreaded words to those borrowing money, but sweet music to investors.

Canadians caught in the fervor to save on non-deductible mortgage interest and in the frenzy to earn tax–protected RRSP interest are overlooking a combination of mortgages and RRSPs that may prove to be an excellent investment.

The greatest annual investment dilemma for many Canadians is, "Should we pay off the mortgage or put money in an RRSP?" Why not do both and put your mortgage in your RRSP? That way the mortgage interest you pay goes into your pocket, not into the overflowing cash hoards of our bloated banks.

An additional sweetener comes when the compounding, or interest on interest, is calculated semi-annually within the tax-sheltered environment of an Registered Retirement Savings Plan (RRSP) or a Registered Retirement Income Fund (RRIF).

Canada Customs and Revenue Agency (formerly, Revenue Canada) considers mortgages secured by Canadian property as qualified investments for RRSPs and RRIFs. However, there are a few rules, including:

• When you hold your own mortgage in your registered plan, the mortgage must be administered by a National Housing Act (NHA) approved lender. Plans which hold mortgages in an at-arm's-length relationship with the borrower do not have to be administered by an NHA-approved lender or insured, however, financial institutions may set their own criteria for RRSP and RRIF qualification.

• The interest rate and terms must reflect "normal commercial practice" and cannot unduly favour the borrower. [bullet] The mortgage must also be covered by mortgage insurance to protect the lender (the RRSP) from default, or nonpayment, by the borrower.

"I have certainly taken advantage of RRSPs from the very beginning," said management consultant Rob Denham, who initially invested in mutual funds but switched to mortgages. "I started investing in mortgages in my RRSP 12 years ago. I suspect since then my [registered plan] has probably grown six fold."

Private lenders like Mr. Denham may command premium interest rates when they lend on less conventional properties. Rates for second mortgages are an additional two to three percent higher.

Mr. Denham normally holds between twenty and fifty mortgages -- mostly seconds -- ranging from $15,000 to $100,000 but concentrated around $40,000 or $50,000. He follows the mortgage-broker maxim of being able to get out quickly if something goes wrong and prefers to lend one-year mortgages, which may be renewed. To further reduce risk, he will not invest if the total amount of the first and second mortgages exceeds 66 percent of the appraised value of the property.

To hold mortgages in your RRSP, you need a self-directed RRSP account. When you start shopping around to find the lowest fees (costs may include about $100 to $500 in annual fees and as much as $1000 in legal fees to set up the mortgage), first narrow down the search by asking whether the financial institution offering the account will allow you to put mortgages in your self-directed RRSP. If you call the big banks or financial advisors who do not understand real estate as an investment, you will be told repeatedly that you cannot put a mortgage in an RRSP. Starting your research with trust companies may save you time.

Invest time to make this investment work. Check out details carefully and crunch the numbers thoroughly to be sure you get the best possible returns out of the RRSP-mortgage relationship and avoid any pitfalls.

Published: December 12, 2000

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Strategist and Futurist is The Catalyst -- intent on "Helping The Best Get Better." An internationally-recognized "new retirement" authority, PJ's research, writing and speaking programs focus on decisions Baby Boomers face to achieve a successful future. Author of 6 books, PJ knows that, since home is headquarters for the "new retirement," professionals and consumers need relevant knowledge and insights, along with solid decision-making skills, to protect and enhance this private oasis. As The Catalyst, PJ provides strategic communication, client appreciation and advanced education services to the financial, tourism, lifestyle and service sectors -- and the clients they serve. A frequently quoted financial and business commentator, PJ is a thought-provoking strategic speaker who offers practical, real-life suggestions on leaving "the box" behind and embracing Forward Thinking -- a talent she regularly demonstrates in this column. For more, visit TheCatalyst.com.