Many of you either have or are familiar with a Tax Free Savings Account (TFSA) & Registered Retirement Savings Plan (RRSP). There is a common misconception that the only way to contribute using a TFSA or RRSP is through a bank investing in low yield GIC’s, savings or mutual funds.
The problem with investing at the bank level, is that no one wants to earn 1-2% return. You’ll be saving for your grand children’s retirement at that rate. So what other options do you have?
Let’s talk a little bit about the Tax Free Savings Account or TFSA. Canada Revenue Agency introduced the TFSA in 2009 allowing you to save up to $5,000 post-tax annually and in 2013 that amount was increased to $5,500 per calendar year. All profits & earnings made through your TFSA are 100% tax free. Contributions are cumulative meaning if you started your TFSA in 2009, as of January 2014 your TFSA contributions could be as high as $31,000.
Some restrictions apply to withdrawing and re-contributing to your TFSA in the same taxation year, to find out more about TFSA’s visit the government of Canada web site at: http://www.tfsa.gc.ca .
What if I told you that earning 15%, 18% or even 25% in your TFSA was possible with little or no risk or headache? sound too good to be true?
Both your RRSP and TFSA are eligible for what is called a ‘Self Directed’ placement. A self directed placement means you can deposit your savings with a Trust Company and direct exactly where and how your savings are invested allowing you to choose the particular investment product best suited for you.
There are a number of different options as to how you can direct your TFSA or RRSP, some of which are stocks, bonds, index funds and Mortgages.
Personally, I like mortgages. With the assistance and guidance of a knowledgeable mortgage professional you can significantly reduce or eliminate your risk while still making a fantastic return. You choose each mortgage deal personally, direct your trust company to make the investment/mortgage loan, the monthly payments and payout of the mortgage are then returned to your TFSA which can in turn be drawn on at any time without penalty or hold back.
The big difference between a mortgage and a personal loan is that when you lend a mortgage your money is secured against the borrower’s property. If the borrower defaults, you are entitled to commence foreclosure to collect your debt. All transaction fees are paid by the borrower, including broker fees, legal fees and collection / recovery fees, if any.
For example, suppose you have maxed out your TFSA of $31,000. You find a suitable mortgage deal you are comfortable with which earns you 17% APR, that’s $5,270 100% Tax Free dollars you would earn in one calendar year. If you saved another $458.33 every month to max out your yearly TFSA by the year end, given the current the contribution allowance, earning 17%, your $31,000 initial investment would grow to $63,613.95 in only 36 months! That’s over double of your initial investment in three years, completely tax free! If a borrower pays out the mortgage earlier than the term, generally an early payment penalty would apply (I advise my clients to set it at 4 months) which means you will have 4 months to re-invest before your money stops working. If you re-invest sooner, you simply earn more interest.
As with any investment, mortgages are not risk free, however, you can substantially reduce and in some cases eliminate your risk by following a few simple rules:
- Lend only in Metropolitan areas – Avoid small communities and rural areas were the local economy is largely dependent on a small amount of variables. Stick to large cities and Metropolitan areas exceeding 100,000 occupants.
- Lend only on Primary Residences – Unless you are a seasoned investor, stick to homeowners looking to borrow on their primary residence. Avoid rental properties, commercial properties and alike. There is nothing wrong with these type of properties but a homeowner has a lot more invested when they are using their personal home as collateral, even if market value declines the homeowner is less likely to default.
- Low LTV – Loan to Value (LTV) means the ratio of Loan to the value of the Real Property used as collateral for the mortgage. For example, if a borrower owns a house worth $100,000 and has a first mortgage with Royal Bank for $45,000 and wants to borrow another $20,000 in second position, the total LTV would be 65%. As a general rule you would stick to 65% to 75% max, if you are an aggressive investor you may go as high as 85% or even 90% but I do not recommend this for non seasoned investors. As with anything, the more aggressive the LTV and risk the more aggressive your return. At 65%-75% LTV you can expect to get a yield between 12-18% APR, on an LTV of 85% or more you can expect as high as 25%+. Please note most trust companies limit the risk to 90% LTV.
- Get an Appraisal – Always get an appraisal or at the very least an inspection even if you are absolutely confident of the value. Even if the value is there, you never know what could be wrong with the house. The cost of appraisal and inspection are traditionally borne by the borrower so it is of no cost to you.
- Check Income – As you are lending primarily against the security (real estate) and not the borrower’s personal security you generally won’t be as picky about credit, income, age,etc. However, it is important that you ensure the borrower has the ability to service the mortgage and has a clear exit (payout) strategy.
- Hire a good lawyer – A good lawyer will look after your interest such as obtaining a certificate of title insurance, the title insurance can protect against any defects in title, land, other issues such as if the property every becomes a grow-op, is built not in compliance, etc. Your lawyer will make sure your mortgage document is tight, that the owners have sufficient insurance coverage to protect your investment and all the other good stuff that keeps you protected from the unexpected. Again, the borrower pays these costs as it is an expense related to creating the mortgage security.
- Use a good mortgage broker – A mortgage broker who specializes in private mortgage lending can assist you with setting up your TFSA and RRSP as a self directed product and help facilitate the process, advise and direct you to potential Mortgage investment opportunities, potential risks and upsides of the Mortgage investment. Don’t worry, the mortgage broker’s fees are also paid by the borrower.
Many Homeowners are looking for cash for all sorts of purposes, renovations, unexpected expenses, investments..etc. If it is a small loan, borrowers expect to pay credit card type rates. Qualification is usually much simpler. Additionally you can participate in larger loans and syndicated mortgages (where several investors advance a combined mortgage). There are also special investment vehicles available for those who do not wish to invest in individual mortgages but would rather be part of a mortgage pool, the returns are less, but still yields are generally seen at 5.5%-9%, a lot better than the bank.
There’s a good reason why the bank takes your money, pays you 1-2%, then lends out Mortages.
If you are interested in these types of Mortgage investment opportunities, have any questions or simply want to know more about investing your RRSP, TFSA or if you are looking for a mortgage please feel free to contact me via email: alex.k@dominionlending.ca or phone; (604) 367-7880.
Some of the things I can assist you with:
- Setting up or moving your current RRSP and/or TFSA to a self directed account without penalty
- Finding and setting up a suitable mortgage investment
- understanding the risk vs. reward and other particulars of this type of Mortgage Investment
Alex Khalil
Mortgage Specialist
Mortgage Evolution Yaletown
C. 604-367-7880 – F. 888-377-7510
www.vanmortgage.ca
Quick closings…. Quick process…. Honest help. #VancouverLending
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