6 Things to Know About RRSP Mortgages: A Legal Perspective.
Do you have a Registered Retirement Savings Plan (RRSP) in Canada? Are you unhappy with the financial performance of your RRSP? Are you looking for better investment returns in your RRSP? Or are you looking to borrow money? Perhaps you don’t want to borrow from a bank, credit union, or broker? If you answered yes to any of these questions, then you might find it attractive to use an RRSP mortgage. This blog post focuses on the legal aspects of lending and borrowing money from an RRSP as a mortgage, but it also applies to other Canadian registered investment funds like Registered Retirement Income Funds (RRIF), Registered Education Saving Plans (RESP), and Tax-free Savings Accounts (TFSA).
In the simplest of terms, here’s how RRSP mortgages work. Someone wants to borrow money, which they will secure with real estate. The RRSP holder lends them the money. The borrower gives the RRSP lender a mortgage with real estate as security. The lender eventually gets repaid—with interest.
There are lots of reasons why people might want to borrow money from someone other than a bank. Maybe you are an investor with rental properties. You have built up some equity and you would like to use that equity to buy more investment properties. Or, maybe you just want to buy a new car.
The kind of mortgages we are talking about here must be ‘arm’s length.’ That’s what the Canada Revenue Agency (CRA) calls situations where you are prohibited from lending to yourself, your children, your parents, your spouse, etc. You might be able to lend to uncles and cousins. There is a potential loophole for investors who use an RRSP mortgage lent to themselves to replace an existing mortgage on an investment property, which I’ve blogged about before (post one, post two). Also check out my podcast on the CRA’s RRSP mortgage rules.
For RRSP lenders, the theory is that instead of disappointing returns on mutual funds or other standard investments, you can invest in a mortgage with a decent interest rate. This certainly can be true, but let’s be eyes wide open. Doing an RRSP mortgage is not the same as going to your local bank. From my side of the legal desk at Field Law, RRSP mortgages are tough. Banks provide a nice, neat, tidy package that basically says, “Barry, we’ve made a loan to Mr. Jones. You do the paperwork.” That kind of loan is easy, peasy. Already negotiated, already set up, most of the important advice—including legal advice—already given. My job as a lawyer is to get that paperwork done on time and on budget. RRSP mortgages are waaaaay different. Not to discourage anyone, but they take much longer to put together, can be way more expensive, and involve more risk. What the heck does that mean, “risk”? Read on.
- If you are lending, you are the bank.
Are you an experienced banker? Do you lend money all the time? Do you understand how bankers look at (underwrite) loans? If you don’t, this makes an RRSP mortgage loan a difficult and potentially dangerous investment for you to make.If you think about it, instead of dealing with a lender who lends money all the time and really drives the transaction, you the RRSP holder are the lender. Not to be mean, but my guess is that most people have no clue about being a lender and often no ability to underwrite the loan as good, bad, or indifferent for their own financial purposes. If you do understand loan underwriting, good for you, but most people don’t.Here’s one example of an extremely important loan criterion. Loan to value ratio (LTV). If you borrow from a bank, the LTV cannot be more than 80% unless the mortgage is insured. Banks understand that having 20% equity in the property is their protection, their cushion against the loan going bad. If they have to foreclose they can usually always get their mortgage repaid because even in a falling market, and with legal fees and other expenses, the borrower’s 20% equity covers the falling value and expenses. Many RRSP mortgages that I see have LTVs of 95–100%. If banks won’t lend above 80%, what is your good reason for doing what the banks won’t do? Always dangerous to risk your money when you don’t know what you’re doing.
- Borrowing money well takes experience
You might be the borrower and be no more proficient at borrowing than the lender is at lending. Of course, that would be different if you have borrowed a lot of money. You might be much more proficient than other borrowers. Still, if lending is not what you do every day, the twists and turns can sometimes trip up even the most seasoned of borrowers. It can be dangerous to borrow, more on that below.
- More parties are involved in RRSP mortgages
Normal loans usually only have a borrower and the lender. In RRSP situations we have a trustee. RRSP trustees have, over the years, beefed up their requirements and those fluid requirements take up a large part of the time that we lawyers spend putting these deals to bed. There are not many trustees doing RRSP mortgages. My guess is that many trustees find these mortgages a pain-in-the-you-know-what and, more than that, unprofitable. Olympia Trust in Calgary is pretty good but they make us jump through hoops. And, as much as Olympia seems to have their procedure down fairly well, our experience is that trustees generally make changes to policies on semi-regular basis without publishing those changes in any really visible way to lawyers. We find out about them when we get involved in an actual deal and go through the paperwork to protect our client’s interests, which takes time. Trustees are not really dangerous unless you classify the potential extra legal time as dangerous—time is money. Probably dangerous to your pocketbook.
- RRSP lenders need a lawyer, borrowers probably do, too
In private, RRSP situations, borrowers and lenders often collectively think that they only need one lawyer. Our Law Society here in Alberta gets very snarky when lawyers act for more than one client. So, who does the lawyer represent: borrower or lender? RRSP mortgages are often driven by the borrower who needs the money. The borrower usually does all the investigation and negotiation with the lender, kind of sets up the whole thing. But, when it’s time to put it all down on paper, it is the lender who absolutely must have legal representation to process the paperwork. Sometimes the buyer can legally do without, but I don’t advise it unless you’ve already done a few RRSP mortgages and really know what you’re doing.
- Legal advice can save your bacon but break the deal
Whether the client is an RRSP lender or borrower, we have to give the appropriate legal advice. When doing RRSP mortgages we try to limit our advice to legal advice. We are not financial advisors and we don’t give our clients economic advice. However, when we see obvious financial issues that might have legal effect, we have to comment.For example, if the total dollar amount of all of the mortgaging on the property is above 80%, then we point out to the RRSP lender that mainline lenders won’t go above 80% unless the loan is insured. It’s those kinds of things that we point out and that can throw off an RRSP lender if they don’t understand how it all works. In Alberta we have a quirky rule that says: where an uninsured mortgage is in the borrower’s personal name, the lender’s remedy is limited to foreclosing on the property. If that foreclosure doesn’t give the lender back all their money, then they cannot sue the borrower personally. Particular to Alberta but, still, we have to tell a lender and if the lender doesn’t know, ka-boom! There are other issues like this example where giving entirely appropriate advice can sink a deal.
- RRSP mortgages are time consuming
The result of all the above observations is that we have found that RRSP mortgages take at least twice as long as a normal mortgage. Much of that time has to be spent by a lawyer and not by our competent staff. When time expenditure goes up, your legal account goes up. Everyone is expecting sort of standard $1,000 plus or minus legal fee (plus disbursements and GST), but the time expended is often double. We have to bill these files on a timekeeping, hourly basis rather than a quoted fee because there’s no way to tell how long it will take.
- If you are lending, you are the bank.
My goodness, what a doom and gloom post! As I reread it, you would think that no one does RRSP mortgages. That is certainly not true. RRSP mortgages, and registered fund lending more generally, can be a great way to get a better Return On Investment (ROI) than you would get from mutual funds, bonds, or GICs. They can also provide funding to people who might not want or be able to get another loan from the banks.
Whether you are a borrower or a lender, it’s like anything else in life. To get good at something, you have to educate yourself, get started, work your way through the difficulties, and get good at what you’re doing. That’s exactly how to be successful at RRSP mortgages.
Being an RRSP borrower
If you are going to be the borrower then, typically, you have to lead because your RRSP lender usually won’t know anything. You probably need at least a one-page commitment letter that sets out the terms of the mortgage. A checklist of things that the lender has to do is extremely useful. You need some experience in determining whether the loan is a good deal and a good idea for your lender. Your ability to put together RRSP mortgages, presumably with the idea that you would like to do more, depends on making that first RRSP loan successful. You have to underwrite those loans vigorously to make sure you can repay!
Being an RRSP lender
On the lending side, you can’t be passive. If you know nothing about being a lender then, like the borrower, you have to educate yourself. Investigate your borrower, ask lots of questions. Do they know what they’re talking about? What security is being offered? Why does the borrower need the loan? Why are they so sure they can pay back? Did you get a credit report? You get the idea: listen to your borrower. Of course, you need to trust, but always verify.
Borrowing and lending from registered funds can be a fabulous idea for lots of different reasons. Stay tuned for a video coming soon that shares the experiences of investors who have successfully used RRSP mortgages. Then get out there and get going!
If you’re working on borrowing or lending using registered funds in Alberta, get touch with Barry at Field Law in Edmonton today!