This is a reader story from Kevin in Toronto, who, after getting laid off, took an unconventional approach with his locked-in retirement account (LIRA) – paying off his mortgage and then setting up a LIRA mortgage.
What are the pros and cons of loaning yourself a mortgage from your RRSP or LIRA? Read on for the details.
Growing up, I never had sufficient exposure and education to personal finance. My grandparents lived in a decent home, which was bought at a very reasonable price in an incredibly valuable neighbourhood that benefited from 40 years of real estate growth, all while living more modestly than they needed to.
My parents also bought their home in the booming 1980s when prices and wages were decent, but interest rates were punitive. They eventually moved up the property ladder and into their dream home. All along I was kept in the dark about all this and, as I grew into adulthood, eventually found myself reading more books and blogs around personal finance to learn the context of their history.
First Time Home Buyers in Toronto
Back in 2012, my wife and I bought a house in a family-friendly neighbourhood near a subway station in Toronto. We had both saved up since before we met and knew we wanted something we could start our family in without feeling too crowded for space.
We were lucky and grateful to have saved more than a 20 percent down payment, and we locked-in to a mortgage at 2.99 percent for five years. We have been told how lucky we were to have bought when we did, especially by friends and family who have been left on the sidelines of homeownership.
Fast forward to 2019, after we renewed early at 2.49 percent in 2016 and added two kids and a whole lot of daycare costs to the family, we were looking to renew once more while rates are still considered historically low. Unfortunately, we were not able to get a renewal rate as low as even our initial mortgage. We needed to determine the best option for our renewal considering we may want to move up the property ladder and still have access to an emergency fund.
I became more interested and engaged in personal finance, drawn to the likes of Boomer & Echo for the practical advice and relatable stories of Robb and his contributors. As our family grew, and our situation demanded more personal and financial attention, I knew I had to make sure the money we brought in was being utilized to its best potential.
The Best Laid Plans
Then in 2018, while waiting for our second child to join our family, I experienced a major shock and life setback: I was laid off. This was a double hurt as we knew the impact would be felt both in the short-term – going on EI and utilizing severance pay – and long-term that I was no longer enrolled in a defined-benefit pension plan.
At the time, I decided to take the pension money and manage it myself inside a LIRA, or Locked-In Retirement Account, in case I found myself in another workplace pension and could use it to buyback service. However, my new job only has a defined-contribution pension, so I’m left to manage my LIRA on my own, with no ability to contribute to it and no early access.
I knew I’d have to be a prudent investor to carefully grow this retirement fund in the age of rock bottom interest rates, low fixed income yields, and the tail-end of a long-running bull market. How can I get this to grow enough to meet my retirement goals?
My Mortgage Gambit: How To Set Up an RRSP or LIRA Mortgage
Here’s where our mortgage and my LIRA will come together, and I embark on what I jokingly call the “Mortgage Gambit” (in honour of Norbert’s Gambit): I’m going to stop worrying about my retirement fund and raid my LIRA as an RRSP mortgage!
Starting this process early in 2019 allowed us to do the research and take stock of what was needed to have in place to be able to raid my LIRA at mortgage renewal time in mid-2020.
First, I needed to have a LIRA with an institution that can hold a Non-Arm’s Length Mortgage. Fortunately, I happen to already be a customer with the brokerage arm of a big bank that can hold a mortgage in an RRSP.
Second, we needed enough money in said LIRA to cover the balance of the mortgage. Since I could not add funds to the LIRA, it meant having to knock down the remaining principal of our mortgage debt.
After many years of diligent TFSA contributions, and the severance from my lay off, we planned to use our savings to pay down the balance over two calendar years using the mortgage’s prepayment options.
My wife and I began to slowly exit our investment positions and hold cash or short-term GICs to ensure we would not compromise our plan. We would track and control our spending for the year, limiting purchases to necessities and travel to a minimum. By the end of 2019, we would maximize the annual mortgage prepayment and then, in the beginning of 2020 before our renewal, we would make another prepayment to bring our balance down to below the amount available to hold the mortgage in the LIRA.
Third, we had to visit the bank and ensure they would allow us specifically to engage in this plan and that we met all the requirements. Thankfully, we would qualify and got a rough idea of the costs and what our interest rate might be. We would have to pay a set-up fee, an annual maintenance fee, a CMHC premium (as a requirement for Non-Arm’s Length Mortgage), and some legal fees.
The eligible interest rate was the bank’s posted 1-year open rate. After crunching those costs, and considering those factors, we still decided to pursue this endeavour.
Why I Took This Approach With My LIRA
Now you might be asking, “why would someone go to this hassle when he could just renew with a “vanilla” mortgage and invest aggressively in his LIRA to get the returns needed to grow it over 20 years?”
I thought about this, as a Couch Potato or Four-Minute Portfolio seemed appealing for the LIRA. It all came down to the one thing most Canadians, especially our dual-income, kids in daycare, contemporaries struggle with: cash flow.
While we are grateful to no longer be living paycheque-to-paycheque, we wanted our kids to have a standard of living that would allow us to have fun and feel comfortable without going into debt or dipping into our savings.
When my wife went back to work in mid-2019, after being on parental leave, we started paying for full-time infant daycare while already covering before & aftercare for a kindergartener and started feeling the pinch. When we felt short on both time and money, we resorted to dipping into our savings more regularly than we were comfortable with.
As I alluded to earlier, we bought the house knowing we’d have enough room for our family, but we knew we’d feel cramped when our kids got older. We wanted to move up the property ladder in the near future, and if we were dipping into savings every month and watching the housing market jump in value every year, we were concerned we would not be able to move up to a bigger and/or better property when we wanted to.
As the stock market went up, so did my concerns that it could run out of steam and come crashing down. We could not comfortably stomach any more loss of invested savings, especially the funds earmarked for our next down payment.
After enduring some past investment mistakes from my time before I learned to simply my portfolio, I had hurt some of my TFSA with unrealized losses and learned that not everyone should be invested heavily in equities without knowing the risks. Lesson learned.
With these three above concerns, we wanted to stop worrying about our mortgage, the inevitable rise of interest rates, free up cash flow to allow us to save for our next home, put ourselves in a better position to move up the property ladder in the next few years as house prices continue to climb, and have a guaranteed income to grow my LIRA without the ability to contribute. With an RRSP mortgage, I could have it all, with a small fee and a few caveats.
RRSP / LIRA Mortgage Benefits
The benefits of an RRSP or LIRA mortgage well outweigh the drawbacks:
- The money we would have given the bank in interest is now coming back to us. While we will still pay a small portion towards one-time and annual fees, the majority of our mortgage payments come back to us as repayments to the LIRA;
- We benefit from our already low remaining amortization, after previous prepayments, and are putting more towards the mortgage. This equates to a guaranteed return on investment equal to the savings in mortgage costs (in our case 2.49 percent tax-free with no capital gains on our primary residence);
- The money we pay as a mortgage has a guaranteed return on investment as we pay back the LIRA in the form of our mortgage payments at the posted 1-year open rate of 4.5 percent (as of this writing), plus when the cash goes back into my retirement savings account where I can pursue a Couch Potato or Four-Minute Portfolio with monthly dollar-cost averaging. Should the rate go up then I end up paying myself more, and should rates fall I can adjust the amortization and keep the same payment;
- The inability to contribute to a LIRA is superseded as holding a mortgage, allowing us to put back more than we take out in the form of loan payments that include an interest premium to myself and not the bank;
- Reducing our monthly mortgage payment by 80 percent to allow for improved free cash flow to cover our fixed expenses and have money left over to save up for our next house down payment;
- Allowing us to add to the overall amortization of the loan from eight to 25 years without adding to our indebtedness to a bank, as we want to be mortgage free before retirement, since I cannot access the money before retirement anyway.
Risks and Alternatives
We understand the risks involved, that’s why I nicknamed this a “gambit” move. We are putting a large amount of our cash savings towards a debt, albeit a manageable one secured against a valuable (and currently growing) asset, instead of investing it.
We could keep the cash and put it back into our TFSAs and invest it with a risk-appropriate plan. With that in mind, consider that in the past decade while the S&P/TSX has doubled in value, the Toronto housing market has tripled. Can either of these be sustained? I don’t know and I would like to believe that neither do the bulls or bears who have been arguing about either of these markets for as long as I can remember.
What I do know is the simple fact that my family needs to live somewhere, and we love our home, our friends & neighbours, our neighbourhood, and the memories we have made. We want to ensure that we take care of it and can afford to stay as long as we want to. We also want the ability to be able to (in the near future) find the right property to call our next home without too much sacrifice to our lifestyle.
I am not as worried about my retirement (no more than I was since my lay off) because if the bull market finally loses steam and my LIRA takes a hit in value I know that I’m not going to retire in the next 20 years – but we still need to live in our house.
I was more worried about eating away at our savings and if either my wife or I lost our jobs that we’d be able to keep the mortgage payments in check. If the bull market and economy keep roaring ahead, we’ll ideally both keep our jobs. If interest payments go up, the extra money will go back to my retirement and not the bank’s bottom line.
I am looking forward to sleeping a little more soundly and reconciling the loss of a rewarding career with its rare and coveted guaranteed DB pension and take advantage of my circumstances to benefit my family’s security. What do they say about life and lemons?
Thanks to Robb for letting me share my story. While I am not endorsing this move (in fact I asked Robb about it back in March 2019) as one needs to be in the right circumstances personally, professionally, and financially, I wanted to share with my fellow Boomer & Echo readers our story to promote to all those interested and engaged in their personal finance situations to take stock of your overall financial situation and determine what is best for you, your family, and future, and to find ways to keep (legally) as much of your own money in your pocket and still live a life you’re happy and comfortable with.