Investing in Real Estate using RRSPs
It’s RRSP season: that time of year where Canadians look to top up or maximize their RRSP contributions for the previous tax year.
But besides just figuring out how much to contribute to your RRSPs, now is also a good time to carefully consider what your RRSP funds will be invested in and the rate of return you hope to achieve.
Do you know specifically what your RRSPs are invested in? Or do you have a just a general idea, like mutual funds and stocks? Which specific mutual funds or stocks? What happens if those companies you’re invested go bankrupt?
And when it comes to the actual rate of return you are earning, is it really as good as it seems? Or is it an average of all your investments, across the various funds, or an average over several years? Also, how much are you paying in fees?
I have found that many people don’t know the answers to these questions, because quite frankly, they find it too confusing. So, in the end, we just hand over our money to the financial advisors and experts at the bank, and give them control over making our investment decisions. But guess what? Most of the time, these experts get paid regardless of how well our actual investments perform. And then we just hope and pray that when the time comes, we’ll have enough money in our retirement funds to maintain our current lifestyle. How much comfort would you have with this sort of retirement plan?
What if there was a simpler way, where YOU can actually understand what you are invested in, and know that your investments are secured and protected, by an actual physical, tangible asset?
Do you know that you can lend out your RRSPs and other registered funds as mortgages?
Wouldn’t it be nice to earn a pre-determined, FIXED rate of return on your RRSPs and TFSAs, without worrying about market fluctuations or additional fees?
Essentially, this investment strategy is a form of private mortgage lending, where you get to take advantage of some of the tax benefits associated by using registered funds, such as RRSPs, LIRAs, RRIFs, TFSAs, etc.
How does it work?
(For simplicity, I will use the term RRSPs in the examples, but understand that this applies to all registered accounts, such as the ones mentioned above):
- You lend your RRSP funds out as an arm’s-length mortgage against a property, and charge the borrower a % on the amount lent out.
- Your earnings are therefore pre-determined based on the % interest rate you want to charge, and you also get to decide the other terms of the loan (payment frequency, pre-payment ability, length of the loan, simple vs. compounding interest, etc.).
- Essentially, you become the “bank” and hold either a 1st or 2nd position mortgage, against a property owned by the borrower.
- Your investment is therefore secured by real estate. If the borrower doesn’t pay you as per the terms of the agreement, you can pursue legal action to take over the property for which you hold the mortgage (just like a bank would through a Power of Sale).
- The income you earn is deposited back into your RRSP, which means you benefit from the tax advantages associated with such a program.
Here are some other key things to keep in mind if you choose to implement this strategy:
- Your RRSPs must be in a self-directed account with a trustee that allows you to lend them out as arm’s-length mortgages. There are only a handful of companies that allow this (I use Olympia Trust).
- Transferring your funds over to a self-directed account with a trustee is easier than you think! Basically, the trustee and financial institutions facilitate the transfer on your behalf, and it does NOT involve you withdrawing your RRSPs into your personal income.
- All fees are typically paid by the Borrower, including YOUR legal fees.
- Understand the borrower’s exit strategy – meaning, how are they planning to pay you back? Will they sell the property? Re-finance?
- Make sure the get an appraisal to support the value of the property and never loan up to 100% of the value of the property. That way, even if the borrower defaults, there is still enough equity in the property to pay you out, and recover your initial investment – that equity is your protection!
Personally, I believe that if done correctly and with the proper knowledge, investing your RRSPs in mortgages can be far less risky than investing them in mutual funds or stocks. Plus, you can have more control and comfort with this investment strategy.
Still have questions? Feel free to reach out to learn more about RRSP mortgage investing.