RRSP Loans vs Cash Back Mortgages

RRSP-Loan-or-Cashback-MortgageThe deadline for making a 2011 RRSP contribution is February 29, 2012.

Making that contribution can save you anywhere from hundreds in taxes to over $10,000 depending on your province and tax bracket. Plus, you’ll enjoy the tax-deferred long-term growth of that investment while it sits in your RRSP.

The challenge for some, however, is not having enough money to make an RRSP contribution. According to Investors Group, 58% of those not investing in an RRSP say it’s because they don’t have the funds.

One possible solution if you’re cash strapped is an RRSP loan. Another is a cash back mortgage. We examine the pros and cons of each here…

Cash Back mortgages give you anywhere from 1-7% of your mortgage in cash on closing. You can take that cash and immediately make an RRSP contribution with it.

RRSP loans are a little different. They’re basically just straight loans secured against your investments instead of your house.

Each has its relative benefits…

Cash Back Mortgage Advantages

  • Monthly payments are typically lower on the funds borrowed for your RRSP contribution (That’s because the amortization period of a mortgage is usually longer than an RRSP loan.)
  • Most, but not all, mortgages compound semi-annually. RRSP loans often compound monthly, which is slightly more costly (Albeit, the difference is far from enormous.)

RRSP Loan Advantages

  • You can sometimes borrow more for your RRSP with an RRSP loan than with a cash back mortgage, depending on the mortgage amount and lender.
  • Unlike a cash back mortgage, there is no clawback of cash to worry about (If you break a cash back mortgage early, you typically must pay back a pro rata portion of the cash you received. Beware that some lenders make you pay it all back, even if you’re just a few days until  maturity.)

Another key differentiator between these two options is the interest rate.

interest-ratesRates on RRSP loans currently range from roughly 3-7% depending on institution, loan size, qualifications, term, etc. That means you’ll pay roughly $200-$550 interest per year for every $10,000 borrowed.

Cash back interest rates are usually 0.40% to 2.00% more than a regular fixed mortgage. That translates to about 3.60% to 5.29% today. The actual rate depends on the mortgage term, lender and cash back amount, among other things.

Despite the higher-than-normal mortgage rate, people often forget that the effective rate of a cash back mortgage is substantially lower. That’s because the lender is handing you cash up front, which reduces your overall borrowing cost.

In fact, for large mortgage amounts and shorter terms, you’ll occasionally find effective rates that are actually lower than a regular mortgage.

Once you solidify your interest rate, you’ll need to determine your payback period. In other words, how long will it take you to repay the money borrowed for your RRSP contribution?

Key Point:  RRSP loans are meant to be short-term. That can’t be stressed enough. Otherwise, the borrowing costs eat up the gains.

Even if you’ve used a cash back mortgage and amortized your RRSP contribution over 25 years, you absolutely and unequivocally need the discipline to pay back the RRSP portion quickly (usually within 1-3 years, depending on the rate, RRSP return, amount of tax refund, etc.).

With the interest rate and payback period determined, you can then compare the interest cost to your gain. That gain includes both the RRSP tax deduction and your projected investment growth. This, in part, will confirm if borrowing for your RRSP is worth it.

Assuming you do borrow to contribute, you can generally expect a tax refund. Use that refund wisely. Financial advisers often recommend one of three things:

  • Prepaying your RRSP loan with it (Doing so lowers your interest expense, which is not tax deductible)
  • Using it to pay off high-interest debt
  • Using it to make an RRSP contribution for the current year

Before we wrap things up, it’s worth mentioning one other alternative to a cash back mortgage: a regular refinance.

Rates on a regular refinance are generally (but not always) less than the effective rate of a cash back mortgage. But a refinance comes with issues of its own.

You will:

  • Need enough home equity to refinance.
  • Face default insurance premiums if your loan-to-value (LTV) is over 80% (85% LTV is the limit if you want the best rates.)
  • Pay a penalty if you have to break a closed mortgage early. (Mortgage penalties often ruin the math and make borrowing for an RRSP contribution uneconomical via a mortgage.)
  • Pay legal fees to refinance. (By comparison, legals are often paid by the lender when you “switch” into a cashback mortgage at maturity. Lenders occasionally cover legals on regular refinances as well. (Just watch out that they don’t charge you an offsetting rate premium in return.)

Whether RRSP borrowing (of any kind) is right for you depends on your tax bracket, contribution room, ability to handle more debt (even if short term), risk tolerance, time till retirement, and likely payback period, among other things. An independent financial advisor or accountant are good sources to help you sort it out.

Related RRSP Tools:

Rob McLister, CMT

  1. Hi Rob,
    Great article. Excellent site. How about using an existing HELOC to finance an RRSP contribution? Thoughts?

  2. Hi Rob…
    As always, a great rundown of the advantages/disadvantages of a common borrow-to-invest strategy.
    That said, I question whether a cashback mortgage can ever be practically sold as a good strategy. For starters, you mention that the effective rate of a cashback mortgage is “occasionally” lower than a regular mortgage. “Occasionally” can’t be stressed enough (with the exception of some very great CIBC cashback offers last year, I can’t think of many) – the vast majority of these terms are at materially higher effective rates and are unintended weapons in the hands of bad advisors.
    Secondly, borrowing to invest in an RRSP really only benefits those who stand to reap substantial return by deferring income tax. A large percent of the population may indeed be far better off maximizing a TFSA before anything else.
    Third, because cash-back mortgages are for the most part fixed rates, the rate of return required to offset the cost of borrowing is not available without taking on risk. In an adverse market environment, it may very well be that the strategy is a net-negative, even after tax savings (which incidentally can’t be calculated since future income tax rates are unknown).
    Forth, cashback mortgages are always a nightmare during a mid-term liquidation due to the clawback (which you pointed out). There are many scenarios under which somebody who has borrowed to contribute to an RRSP can find themselves in severe financial distress.
    In practicality, cashback mortgages shouldn’t ever be considered a good idea unless a very experienced mortgage professional can point out a situational advantage with a lender’s pricing. Take it from me, these don’t come around often.
    Hopefully brokers/agents won’t read this headline and think they’ve found a new niche as tax time rolls around.

  3. “Third, because cash-back mortgages are for the most part fixed rates, the rate of return required to offset the cost of borrowing is not available without taking on risk. In an adverse market environment, it may very well be that the strategy is a net-negative, even after tax savings (which incidentally can’t be calculated since future income tax rates are unknown).”
    Precisely. This cannot be stressed enough as 2012 is shaping out to be a very volatile year for the markets. Don’t rush to invest because of the headlines about declining unemployment in the U.S. as they’re digging out of a very deep hole. Generally, a 5-year 5% cash-back mortgage is priced at +/- 5-year posted rate. While the effective rate is obviously lower because of the cash provided up front, it is only lower if the applicant actually uses that money to build wealth as opposed to spending it on things that lose value quickly. Using the cash-back portion to pay down high-interest debt, prepay the mortgage (a guaranteed ROR) or invest in low-fee, tax-efficient index funds is a wise move. But spending it on a vacation or new entertainment center is completely detrimental because now you’re paying posted rate which is more than 2% higher than the same mortgage with no cash-back.
    The bottom line is whatever option you choose, there’s a lot of number crunching to do.

  4. Rarely does anyone detail the “disadvantages” of RRSP investments and the truth is they are not the “be and end all” of even a comprehensive retirement plan.
    Of course you will never hear that from anyone in the business of selling you retirement investments or ones reliant on the advertising of such. I know a number of self-made wealthy retirees and I would hazard a guess that not one would tell you that they attained such an enviable position thanks to maximizing their RRSP contributions every year!

  5. Hi Whistler,
    Very helpful comments. Appreciate you taking the time to leave this post because it lets us dive a little deeper in some key areas.
    Let’s look at each point in more detail. I’ll quote you just for reference purposes:
    1) “I question whether a cashback mortgage can ever be practically sold as a good strategy.”
    They can, but as the story and yourself both note, it depends heavily on the circumstances.
    2) “the effective rate of a cashback mortgage is (only) “occasionally” lower than a regular mortgage.”
    Most lenders have lousy effective rates on cashback products, so that’s true.
    The best option is currently available through Mortgage Centre brokers and CIBC with their 3-year fixed cashback offer. If the mortgage is over $400k, the cash back is 3% (which gives it the best effective 3-year rate in the market). For mortgages under $400k you get 2% cash back (or sometimes 2.5% on exception at the branch). A 3-year term also minimizes the need to break the mortgage early and face a clawback of the cash.
    Another example are FirstLine mortgages (pricing permitting) where a FirstLine status broker is providing cash back from floating the rate, using a quick close and/or using banked basisPOINTS. Moreover, with that product there is sometimes no clawback, if the cash received is 2% or less. (That said, you’ll need a big mortgage to generate enough cash back at 2%.)
    And yet another option is a quick-close cashback mortgage at ResMor, with an effective rate that’s as good as most bank-quoted rates.
    In cases where the cashback mortgage’s effective rate is higher than a normal mortgage, one has to be especially aggressive in prepaying the mortgage, and be confident that the expected after-tax returns will outrun the cost of borrowing.
    3) “borrowing to invest in an RRSP really only benefits those who stand to reap substantial return by deferring income tax.”
    Yep, but that’s a good number of people. It’s also beneficial in the short term for those who will earn a sizeable tax refund, assuming the total cost of borrowing is reasonable.
    4) “the rate of return required to offset the cost of borrowing is not available without taking on risk.”
    That’s true. Risk is inherent in the majority of investing strategies, especially leveraged investing. A long-term time horizon is essential for mitigating this risk.
    On the topic of risk, when it comes to leveraged investing it’s strongly advised that folks seek the counsel of an experienced independent financial adviser. It’s crucial to have another set of trained eyes run through the math and assumptions before diving in.
    5) “tax savings…can’t be calculated since future income tax rates are unknown”
    Tax benefits are a fundamental precept upon which RRSP investing is built. In the short term, the tax benefits are always known (i.e. you know how much your tax refund will be from making an RRSP contribution).
    In the long run, the tax you pay at withdrawal is indeed uncertain, but assumed to be roughly similar to today +/- a few percent. One can shun RRSP investing for fear of considerably higher future tax rates, but that would likely be a mistake.
    6) “cashback mortgages are always a nightmare during a mid-term liquidation due to the clawback”
    This is certainly worth repeating. Unless the borrower feels confident they won’t break early (and their financial profile supports that at the time), mortgage advisers should almost never recommend a cashback mortgage.

  6. now i know why my mortgage company has dropped rates on their cash back offers….thanx rob…. but does this mean thats the only rates that will drop between now and the end of the rsp deadline?

  7. Thanks Rob – No problem with any of the above.
    One point that is interesting to note is that in 1965, consolidated income tax rates for the average Canadian were 5% lower (and CPP contribution rates were 1.8% versus the 5% now). You mentioned that “a long-term time horizon is essential” for investment return, and I’m in complete agreement, but I think that the long-term trend of higher taxation rates can’t be ignored either. I’m a big proponent of contributing to TFSA’s first because I’d rather take my medicine today than have it administered to me at a presumably higher rate on the back end. Admittedly I’m only 33, so I’m much more worried about this than somebody who is 60 and in the top bracket and looking for a short deferral.
    Sorry for the aside…great points as always.

  8. Why focus on one year? Investing for retirement is not a one-year proposition. It is the long run returns that matter.
    There is also no need to invest with blinders on. Qualified investors can tap some great RRSP investments that don’t involve simply buying stocks and mutual funds.

  9. I don’t see you detailing any disadvantages of RRSPs either.
    The reality is, not everyone is a “self-made wealthy retiree.” Maximizing RRSPs and TFSAs are the best chance most ordinary Canadians have at a comfortable retirement.

  10. “Maximizing RRSPs and TFSAs are the best chance most ordinary Canadians have at a comfortable retirement”
    Sounds like you read that verbatim right off the front page of your RRSP sales manual.
    That’s the exact cookie cutter, one size fits all, RRSP marketing crap that F.I.’s have been shovelling for decades without any proof its a proven retirement strategy.

  11. Investing in retirement is a very risky business, for few to gain, many have to loose. You better know how to be on the winning side :)

  12. Many thanks Appraiser. Using a HELOC can be a decent alternative assuming:
    * one has the available equity
    * doesn’t need the HELOC for anything else
    * the rate and fees are competitive (e.g., prime + 0.50% with minimal set-up cost).
    HELOC payments are often interest only so that keeps carrying costs low (if this is the borrower’s goal). Then again, many RRSP loans offer deferred payments as an option in such cases.
    A HELOC also avoids any cashback limitations.
    Not surprisingly, the right option depends largely on the rates, requirements and alternatives available to the client.

  13. I would like to question the wisdom of even contributing to ones RRSP (unless you make over $250,000/yr.). And most important statement that the contribution can “save” you thousands of dollars in tax is untrue. It only earns you a tax deferral – you’ll have to pay tax on that money when you take it out (in retirement maybe?). Taxes are only going up steady as one poster said earlier correctly. And you have no idea how much tax you’ll be paying on that money when you take it out, plus the headache of watching it invested over the working years. Ask your friends how are their investments doing right now? Most lost.
    So, no thanks. I pay the tax now and if I have some cash left over I put it in TFSA account only.
    The bigest profit I ever made was paying down my mortgage faster and carying no balance ever on credit cards.
    I’ve been listening for the last 20 years to the endless discussions on what is better – pay down mortgage or invest in RRSP or take out a loan to top up RRSP or use a tax refund and prepay the mortgage with it or ….. Never ends, and NO ONE has come up with an answer yet. Because the truth is this – pay down your bigest debt first before you embark on investment road. So if you carry a mortgage focus on that and forget about investig elsewhere.
    Another fact is this – when you retire RRSP income has to be reported and might reduce your entitlement to other government supplements (many have lost them because they diligently saved when young). How absurd is that? Take that vacation now, eh?
    You need to have as little reportable income as possible when you retire , and TFSA and real estate are the only two choices I can think of right now.
    Some people might not agree with my reasoning, those are the ones not getting a fat comission because I refuse to invest in anything other than my mortgage, TFSA and my travel agent.

  14. So true, like I was reading my thoughts.
    Nothing is designed by the govt to help the average people.
    RRSP may benefit some, but it’s not for ALL. Naive people go for it , and for Savings for School programs …
    All designed to lock your money and use them while you’re waiting for the brightest future, which we all see isn’t sometimes that bright.
    But, if there are no loosers, there will be no winners.

  15. IMO this statement is just totally false: “for few to gain, many have to loose.”
    If everyone invested in a good globally diversified dividend-paying index fund, everyone would win. The market increases over the long term and lifts all boats. History has proven that time and again.
    When you invest properly, investing is risky only in the short term.

  16. Drazen, you present some great arguments against RRSP’s.
    There is also another important one that is worth noting. I have seen examples of people who have died before they converted their RRSP’s and where the full RRSP value has to be taken into income and taxed at the maximum rate (46.4% Ont./43.7% BC.) These were not necessarily wealthy people since $128,800 gets you into the top tax bracket.
    As you mentioned, who knows what the tax rate will be in future years or what inflation will do. In the U.K. in 1974, the top marginal rate for income tax was a whopping 98%!
    How’s that for peace of mind retirement investing?

  17. Fussing about future tax rates is absurd. You guys can argue that RRSPs aren’t right for everyone, but citing unknown tax rates 20 years from now is a weak argument on a good day. Personal rates have trended lower for 30 years. The top federal rate was 43% in 1981. Today it’s 29%. There is no reason to believe that course will be reversed. Marginal rates could just as easily keep falling if tax receipts increase.

  18. Rob you make a good point:
    On the topic of risk, when it comes to leveraged investing it’s strongly advised that folks seek the counsel of an experienced independent financial adviser. It’s crucial to have another set of trained eyes run through the math and assumptions before diving in.
    A note here…you will likely find borrow to invest in your RRSP pushed by mutual fund sales reps as they can get paid on the RRSP loan also, and will DSC the mutual funds.

  19. I challenge anyone who is currently investing in RRSP or other investments to ask their current advisor what their sell discipline is. I believe that it is much harder to define a sell disciple than a buy discipline. Mutual fund sales reps will always say dollar cost average…sorry but ask many people how well that has worked in the last 10 years. For business owners, I would generally suggest a IPP, this way you can actually deduct the expenses that you pay in your IPP.
    If your advisor doesn’t know about an IPP, time to change.

  20. Drazen, Banker, and others…
    Thank you for the posts.
    When it comes to investing, generalizing can be hazardous so let’s hash this out.
    First, let me remind that this is not investment or tax advice. Consult a financial professional for definitive information on tax or investing issues. What follows is just personal opinion based on experience, and shared only to put the above story in context.
    The intention of the article is not to advocate for RRSPs. It is simply to compare solutions for people who would benefit from an RRSP contribution but who don’t have the ready cash.
    That said, let’s set the record straight about one thing. It is absolutely possible to save thousands of dollars in tax by making an RRSP contribution. More on that below. Like any tax or investing strategy, savings and returns depend on the circumstances.
    Clearly, RRSPs are not a one-size-fits-all program. Their benefits depend on the client, assumptions and circumstances. TFSAs are often superior to RRSPs for those who are:
    * Expecting to be in a higher tax bracket at retirement
    * Low income earners
    * Without RRSP contribution room
    * In need of withdrawal flexibility
    * Involved in a company pension plan
    * Nearing or in retirement
    * Needing to rely on government benefits in retirement
    Moreover, there are instances where non-registered investments and alternative strategies trump both RRSPs and TFSAs. This can be the case for people having certain unregistered investment opportunities, for people who own their own company, etc.
    (The above lists of suitability considerations are by no means exhaustive.)
    Back to RRSPs. Compared to TFSAs, RRSPs do save a significant amount of tax (not just defer it) for a large percentage of the population.
    The most frequent example applies to those Canadians who retire in a lower tax bracket than they had during their working years. Those individuals will pay less tax on $1 of income earned today if that $1 is contributed to an RRSP and then taxed at retirement.
    In addition, RRSP limits are 4.5 times greater than TFSA limits. That allows many people to generate significant tax deductions today, that wouldn’t be possible with TFSAs alone. Even if saving tax today means paying tax later, the value of a tax deduction now can be far more important (for some) than the tax liability they’ll face at withdrawal.
    RRSPs have other benefits as well including:
    * Higher contribution limits which let people build bigger nest eggs than with TFSAs alone
    * Better tax treatment of US dividend stocks (compared to TFSAs and non-registered accounts)
    * Access to the RRSP Home Buyer’s Plan
    * More disciplined investing since it’s more expensive to withdraw from an RRSP than a TFSA.
    * The ability for self-employed individuals to invest the tax refund in their business to boost revenue and personal income.
    * The ability to use the RRSP tax refund (when appropriate) to pay down high interest debt
    Simply put, there are too many cases and caveats for a comprehensive analysis here. The point is simply that RRSPs are one of the very best options for some people. Hence, it makes sense to analyze the methods of borrowing for an RRSP contribution when doing so makes sense.

  21. Vic…that’s why I mentioned consolidated tax rates, not just federal. You’re absolutely right that future tax rates alone are not a reason to shy away from RRSPs, but there are many other reasons as people have mentioned. I was simply saying that RRSP’s aren’t the panacea the financial industry has been selling us for decades.

  22. Also cashbacks come with extremely high interest rates.
    a 1% cashback comes with an increased rate of 0.40%.
    On a 100k mortgage thats $1,000 loan and $400 of added interest per year. That puts the effective interest rate closer to 40% NOT 3.6 to 5.29%.

  23. Cameron:
    An IPP is certainly an attractive option but as you have said it’s not for the broader demographics. It’s mainly designed for those in their mid-careers, preferably running a business who earn a minimum six figures. There’s also the cost component of starting an IPP and structuring it properly but it is directly deductible.

  24. Borrowing to fund an RRSP contribution is very much a 1-year proposition. If you don’t have a strong belief that your investment won’t be worth more than it cost (adjusting for interest, tax benefits, etc.) next year at this time, you shouldn’t do it.

  25. I could be wrong, but when I ran the numbers on a TD cash back mortgage, I found that the rate was about equivalent to a blended rate of the best rate they offered on 95% of the LTV, plus about 28% on the cash back portion; basically a vanilla high-ratio mortgage plus a cash advance on a high-interest credit card. E.g. right now TD’s “special offer” rate is 4.09, but their posted rate is 5.29. 95% x 4.09% + 5% x 28% is… 5.29%
    Am I missing something?

  26. Great article and some strong opinions out there!
    Some missing points on the strategy so far:
    Spousal RRSP contributions – They can be used to help SPLIT income for the family with a partner who does not work or stays at home with the kids while the other brings in the income. The contibution is deductable from the income earners taxes (say 29%) and if the withdrawl is after the transition period will be income for the lower or zero income individual and the tax rate may be 0% if the total income is below your provincial limit.
    Some details about the CIBC quick close cash back offer which is not for everyone:
    4yr fixed rate: 3.44% + (2% – 3%) cashback
    (3% for mortgages over $400k)
    equivelant rate: 2.69 – 2.94%
    After the mortgage is in force clients can refinance with a same term blend and add more funds or port to a new property and the cash back stays with the mortgage. It is sticky in that clients have more to consider when looking to leave as they would have 100% repayment of the cash back.

  27. John
    Your statement is deceptive. Cashback terms differ. CIBC will give 3% cash on a three-year $400,000 mortgage at 3.50%. The cashback is not a loan like you said. The $12,000 is given to you. You don’t pay it back unless you discharge the mortgage early.
    Based on your formula this person pays .5% more for three years, or $6,000. That is way less than $12,000 but the math is not that simple. You have to compare the cash, tax refund and assumed investment gain to the $6000 to determine the net borrowing cost and rate of return. In this case someone in a high tax bracket is well ahead at the end of the day.
    By the way, great posts on this topic Rob.

  28. It’s all about possibilities. “could” you say.
    Well, I better live and invest in what I know today than hope for tomorrow.
    Ultimately – your RRSP dollars serve others than you and IF you’re lucky, or very knowledgeable you may get some benefit of them too.
    All the rest – average Joes – you can just hope that the future is bright.

  29. I said “most ordinary” Canadians not “all” Canadians. It pays to read.
    In all your crude critique you have yet to state anything that invalidates what I said. If you want proof that RRSPs are a viable investment strategy, I welcome you to Google “RRSP” and read the 2,980,000 entries on the topic.

  30. You don’t have to pay back an RRSP loan in one year. You can take three or five years. It depends on the interest rate and total return.

  31. Spousal RRSP is not required anymore to split income in retirement – now you can do it regardless (check the details on CRA site).
    What I used a spousal RRSP for was this – contributed $20,000 to my wife’s RRSP and received over $8,000 refund. She took the money out after 3 years (min requirement) and claimed it on her income tax. She was in low bracket, I lost a dependant claim on her as a result, BUT we still came out ahead more than $5,000. We did that 3 times for a total of over $15,000 savings in income tax. All legal and clear. It was possible because she was home with kids and did not have any other income.
    Could someone beat that deal, eh? Let me know, I’m all ears.
    And since I can’t use the above strategy right now I would like to know if TFSA account can be used in a similar way, or what are the best (not speculative)investment choices inside it?

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