I want to lend money for second mortgages to others (through a broker). He suggested to invest the money through a self-directed RRSP. Is this a sound advice (it will lower my income tax, and contribute to retirement, but any downsides?). Secondly, if this is such a great option, why wouldn't everyone do all their business through self-directed RRSP
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Can one of my expert Canadian friends tell me - a self directed RRSP, as in the US, can invest in a class of assets regular brokers don't handle such as businesses, real estate, notes, loans, mortgages? So the question is really not Canada centric if the rules are that similar. And my answer, if I had one, applies to both?– JTP - Apologise to Monica ♦Mar 20, 2014 at 15:51
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@JoeTaxpayer, the rules change from time to time, though more frequently with TFSAs than with RRSPs. Hopefully the article I link to in my answer can give you a general understanding of what's possible, though. Basically, yes.– ChrisInEdmontonMar 20, 2014 at 15:53
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@JoeTaxpayer Yes, SD RRSP opens up many choices: stocks (incl. some foreign exchanges), bonds, mutual funds (a large universe, not one brand), call options, call writing, cash (incl. non-CAD, if broker allows), guaranteed investments, etc. Arm's length mortgages are possible -- if the broker is willing to administer (and setup & ongoing fees can be $$$). One's own mortgage, too, provided one can qualify and insure it. Private shares, to a limit, IIRC. Lots of flexibility. Limitations, AFAIK: no shorting, no puts, no uncovered calls. I'm sure I missed something -- don't take as complete.– Chris W. ReaMar 20, 2014 at 16:05
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You can buy puts. So you can essentially short something like that.– brianMar 20, 2014 at 19:56
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@brian Thanks for pointing that out! I forgot about that change.– Chris W. ReaMar 21, 2014 at 0:58
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1 Answer
The Globe and Mail has an interesting article on what you can do with your RRSPs. Be aware that the article is from early 2011 and rules change.
They describe holding your own mortgage inside your RRSP. That is, if you have $100,000 inside your RRSP already and your remaining mortgage is $100,000, you can use that money to pay off your mortgage, then pay back the money at interest, generating a tax-deferred profit inside your RRSP.
That approach may be viable, though you'd want to talk to your accountant first. I'd be very cautious about loaning money to someone else for a second mortgage using my RRSP, though. Second mortgages are inherently risky, so this is a very speculative investment. Once you make an RRSP contribution, that space is used up (barring a couple of exceptions such as the life-long learning plan). So, let's say you used $100,000 of your RRSP to loan to someone for a second mortgage. Any interest payments should be sheltered inside the RRSP (substantial benefit), but if the person defaults on the second mortgage (which you should expect to be a significant possibility), you've lost your entire $100,000 contribution room (as well as, obviously, the $100,000 that you loaned out).
I can't tell you whether or not it makes sense to invest in risky second-mortgage loans and I can't tell you whether, if you choose to do so, it definitely should be done inside an RRSP. There are substantial risks in the loan and there are both costs and benefits to doing so inside an RRSP. Hopefully, though, I've helped you understand the questions you should be asking yourself.
answered Mar 20, 2014 at 15:52
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I had talked to my broker about what happens if the client defaults. He explained that, since there is a mortgage on the house, they will come with a sheriff, evict the owner, get the house keys and sell the house, thus recouping the investment. Is that not the case?– SlavMar 20, 2014 at 16:03
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1The first mortgage owner will be paid off first. If there's any money left, the second mortgage owner will be paid off next. Remember, a house may sell for MUCH less than the outstanding first mortgage in a foreclosure, let alone the second mortgage. If foreclosure happens, you should expect to get between 0 and a small fraction of your investment back. Mar 20, 2014 at 16:41
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Do you have any resource on more about this? Looks like my broker is painting a rosy picture.. @ChrisInEdmonton– SlavMar 20, 2014 at 16:45
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I don't, but there are plenty of books written about the mortgage crisis (en.wikipedia.org/wiki/Subprime_mortgage_crisis), and note that most foreclosures here returned a fraction of the mortgage to the holders of the first mortgage, and none to holders of second mortgages. Mar 20, 2014 at 20:39