Uniquely Canadian

Would Ottawa ever let you deduct the interest on your mortgage from taxable income?

In recent days several people have floated this as a viable option for deliberately reflating a flaccid housing market. After all, Americans can do it. So why not us? Could it happen?

Not a chance.

This would utterly distort a tax system already skewed towards home ownership and be patently unfair to every renter. It would mean the capital gains exemption on real estate profits would have to end. It would exacerbate a real estate calamity already in the making. Worst, it would be completely unaffordable, gutting federal tax revenues at a time when the deficit and debt are a disgrace. In doing so, it would enslave the next few generations with mercilessly rising taxes to subsidize one which borrowed its buns off.

Besides, you can already do a mess of cool things with your mortgage – including making it tax-deductible. I will show you how in a few days. And there’s another action I am asked about all the time, which is putting your mortgage inside your RRSP, then making payments to yourself. Here’s a recap from my current book, ‘Money Road.’

First, you need a self-directed RRSP (the kind you can put virtually any asset inside, with which you make the decisions, and which costs a few bucks a year to maintain.) You must have cash or cashable investments within your RRSP equal to your mortgage, or a good chunk of it. And understand that all this needs to be set up through a financial advisor and a third-party financial institution (like a trust company), which will cost a few thousand in fees to get ignited.

Your RRSP can hold a mortgage on any Canadian real estate – residential or commercial – owned by you or by an immediate relative, such as a parent or daughter. This means existing cash can be withdrawn from an RRSP and then loaned out as a home loan, with the conditions that regular mortgage payments must be made back into your RRSP, and those payments must be at ‘market’ interest rates.

A mortgage is a dream investment for an RRSP to hold, because of the awesome way a home loan throws off money. In the early years, almost all of the monthly payments are interest due to the amortization of the loan, which means over the course of a typical 25-year payback period, roughly three times the original borrowed amount is taken from the mortgagee. When you are both the lender and the borrower, it feels good to screw the little guy.

And while all this cash is being paid into the RRSP, the money can be used within the tax-free environment of your savings plan to invest in growth securities. In addition, once an RRSP mortgage is set up, you’re obligated to make payments into your plan to service it – which does not affect your ability to make new annual contributions. In reality then, you have just found a way to seriously fast-track the journey to retirement independence, and to exceed legislated contribution limits.

Also be aware that unlike a traditional mortgage paid in after-tax dollars to a lender, this is one you’re paying to yourself. So, instead of a low rate and a short payback period, you want the opposite. Think like a banker. Therefore:

  • Set up the loan with a long amortization – 35 years – which means far more interest will be paid into your RRSP than with a conventional 25-year payback period.
  • Since the RRSP mortgage rates must be comparable to market rates, shop around for the highest commercial rate and match it.
  • With rates rising, you might be wise to consider giving yourself a variable rate loan which can be jacked up every time the prime pops.
  • Make the loan an open one, repayable at any time. While you have no intention of doing so, this gives you the highest possible interest rate, plus a convenient way to wrap things up if you sell your property.
  • You can also make this a second mortgage on your property, which will allow you to establish a substantially higher interest rate. It will require more mortgage insurance, by the way, since all RRSP mortgages must be insured through CMHC (which forms the bulk of the set-up costs I referred to above).
  • And construct your RRSP mortgage in a traditional way without any fast-pay techniques you’d normally use as a homeowner, like weekly payments, prepayments or shortened amortization. The idea is to shovel as much money as possible into your RRSP, so stick with a monthly payment.

An RRSP mortgage acts like a conventional one, so you can choose any term you’d like, or even have an interest-only payment. If you default, your RRSP gains ownership of your home – which will be a mess to sort out. While an RRSP can own a mortgage, it can’t own a house, meaning a forced sale would occur. However, if you do default, the mortgage insurance is there to reimburse your RRSP for the amount of the loan. And there are costs involved:

  • The mortgage insurance fee (add this to the mortgage principal, because it is to your advantage).
  • An appraisal, legals and set-up charge for the financial institution administering the loan (this is required, since you cannot run your own mortgage)
  • Your annual self-directed RRSP fee.

The most common complaint I hear from people is the trouble they have in finding help to set up an RRSP mortgage, since they typically start by talking to their bank about the scheme. Big mistake. Banks are in the business of making mortgage loans, not having you pay one off with your RRSP. So, the best first stop is a financial advisor who runs a fee-based practice, like mine, who can get this all done for a modest cost and the least amount of hassle.

This, by the way, is something those retrograde Americans can’t do. So take that.