Self-Directed Mortgages
So, what exactly is a mortgage held within a self-directed RSP?
How does it work, and what are the factors to be considered from a planning perspective?
A self-directed Retirement Savings Plan (RSP) or Retirement Income Fund (RIF) can be used to hold or refinance a mortgage on commercial or residential Canadian real estate.
With a self-directed mortgage, the RSP or RIF becomes the mortgage holder. Since cash is needed to arrange for a self-directed mortgage, there must be sufficient liquid assets in the RSP or RIF for the annuitant to cover the amount of the mortgage loan. The annuitant may need to sell securities to ensure they have sufficient cash on hand in the RSP or RIF.
The rate of return earned on the amount loaned will be equivalent to current mortgage rates or higher.
Income Tax Act Regulations (ITAR) permit both “arm’s length” and “non-arm’s length” mortgages as qualified investments in an RSP or a RIF. However, the rules differ depending on whether the mortgage is “arm’s length” or “non-arm’s length”.
An arm’s length mortgage is a mortgage that allows RSP or RIF annuitants to use the money from their self-directed RSP/RIF to fund a mortgage to a third party not related to them by blood, marriage or adoption.
A non-arm’s length mortgage is a mortgage where the borrower is the annuitant himself/herself or is related to the annuitant. Persons related to the annuitant include the annuitant’s spouse (including common-law), a blood relative or a relative through marriage or adoption.
The main difference between holding an arm’s length and a non-arm’s length mortgage is that, in the case of the arm’s length mortgage, there is no requirement to have the mortgage insured.
For a non-arm’s length mortgage to be accepted as a qualified investment in a self-directed RSP or RIF, the mortgage:
- must be administered by an approved lender under the National Housing Act (which includes most financial institutions);
- interest rate and other terms and conditions must reflect normal commercial and residential practice;
- must be insured either by the Canada Mortgage and Housing Corporation or by a private insurer of mortgages. The mortgage insurance requirement ensures that retirement savings are protected in the event the annuitant defaults on the mortgage.* The insurance fee can be paid as an upfront fee or added to the face value of the mortgage.
*If the annuitant is unable to make his or her monthly mortgage payment, the financial institution will place the mortgage in default. It will then attempt to collect the proceeds upon a power of sale of the property or, if insufficient, from the mortgage insurance.
Note: If the proceeds from the mortgage are being used to finance investment property, the cost to set up the mortgage as well as the mortgage interest may be considered tax deductible expenses. Canada Revenue Agency (CRA) requires a clear audit trail of the investment and the mortgage.