When it comes to investments for registered plans (such as RRSPs and RRIFs), many people often think about traditional options like stocks, bonds, GICs and mutual funds. However, there are other lesser-known investments that are qualified to be held in registered plans under the Income Tax Act, including arms-length mortgages. An arms-length mortgage is a private mortgage between two parties where the lender and the borrower are not related by blood or marriage. These parties act independently, and the mortgage must also be set up where there is no advantage to either party.
Typically, arms-length mortgages are funded with the assistance of a mortgage broker who skillfully manages the transaction between a borrower possessing equity in their property and a lender with available funds to invest. Through skillful negotiation, the mortgage broker establishes terms to which both parties agree and then underwrites the deal. Although a mortgage broker may not always be necessary, if registered plans are utilized and a trustee is involved, the trustee may request that the mortgage be underwritten by a mortgage broker or a licensed administrator, depending on the mortgage and the province.
After the mortgage terms are mutually agreed upon and a commitment is signed between the lender and borrower, the next step is to engage a lawyer. Either the broker or lender will acquire a lawyer to complete the necessary and required documentation. The lawyer plays a crucial role in this process by preparing the mortgage documents based on the signed commitment, conducting a title search as well as collecting other important documents such as property valuation, prior encumbrance statements, estoppel, and insurance documentation. The lawyer ensures that all paperwork is in order and that the transaction can proceed smoothly.
After the lawyer has prepared all necessary documents and if a registered plan is being used to fund the mortgage, the completed deal will be submitted to the registered plan trustee for review and funding. The registered plan trustee will only review the file after they have received all the required documents, and the lender has given their written authorization to proceed with the mortgage investment by completing the trustee’s prescribed form. The trustee will thoroughly review the documents to ensure they are in accordance with the lender’s direction and confirm that the mortgage is a qualified investment. It is important to note that, according to the Canada Revenue Agency (CRA), a mortgage is considered qualified only if the property is on Canadian soil, and the loan-to-value (LTV) of the mortgage does not exceed 100%. When a registered plan is used to fund a mortgage, the mortgage itself must be registered to the trustee as the registered owner. The lender can be registered as “in trust for” and is the beneficial owner of the investment.
In the case of an arms-length mortgage held in a registered plan, the borrower has no direct relationship with the trustee, unlike in a traditional mortgage transaction, where the borrower deals with the lending institution. In this case, it is the lender who is the client of the trustee, since the mortgage is the investment held in their registered plan. The trustee will communicate directly with their client throughout the life cycle of the mortgage, regarding any payment issues or documents received related to the mortgage. Various issues that may arise during the life of the mortgage can include, but are not limited to, items such as returned or cancelled payments, insurance cancellation, tax arrears, maturity, and foreclosure by another encumbrancer, these will all be brought to the attention of the client. Additionally, the client is responsible for collecting any payments in arrears and approving/calculating payout amounts. The trustee forwards these notifications to their client but does not take any action without the client’s instructions.
Investing in arms-length mortgages can require significant involvement from the lender of the mortgage along with the maintenance of the investment. However, for those lenders who prefer a more hands-off approach, hiring a broker or mortgage administrator can be a viable option. To do so, the lender must make the designation in writing and receive approval from the trustee. Once approved, the trustee will redirect all communications to the designated third party for handling, allowing the lender to focus on other aspects of their investment. While the trustee will still communicate with the lender regarding their account, all mortgage-related inquiries and correspondence will be directed to the approved third party.
To determine if an arms-length mortgage investment is appropriate for your financial goals, you are encouraged to consult with your financial planner, tax adviser, or broker. Furthermore, if you are interested in learning more about holding these investments in a registered plan, we recommend that you get in touch with a registered plan trustee that allows arms-length mortgages to be held in their accounts.