Canadian Wealth – Imaginary Assets
The Government tells us that Canadians have significant assets, but many of them are “imaginary assets”. In fact, the Honorable Finance Minister wants Canadians to “unlock” their wealth. Here are a couple of scenarios to think about. According to the Government, the consumer in this case has $200,000 of equity in real property and a $25,000 RRSP – however, in reality the consumer has only $55,000 worth of equity in real property and ongoing liabilities to the mortgage, the RRSP and to the CRA.
The idea that Canadians have money tied up in RRSPs is somewhat illusionary for several reasons. First of all, when you withdraw the money you will pay taxes at whatever you present day marginal tax rate is. Potentially you could see a very significant reduction in the book value as taxes are paid. Secondly, many investment values fluctuate as markets change.
Of course, many first-time home buyers have collapsed RRSPs to purchase real property. In many instances the funds converted never existed in the first place. Banks lend money (RRSP Loans) to invest in an RRSP, then convert the RRSP to a Home Buyers Plan. Creating a double threat to financial well being, in the first place, the loan must be repaid, and since the RRSP money was used to buy the house you also have to pay back the monies withdrawn from the RRSP.
The minimum down payment required to qualify as a first-time home buyer is 5% of the purchase price. A first-time home buyer is also required to pay CMHC Insurance with a premium of 4% of the purchase price, since the 5% down payment gets chewed up in costs the first-time buyer ends up with a mortgage that is at least equal to the purchase price. Meanwhile, the RRSP has no funds in it and must be replenished (a liability).
Imaginary Equity in Real Property
The Government tells us that we have money “locked up” in real property, but do we really? The average house price in London, ON, is currently around $500,000. Let us assume the house has a mortgage of $300,000 – according to the Government there is $200,000 of equity. But not so fast, the average real estate commission is 5% – so the realtor would be paid $28,250 (commissions plus HST).
And of course, there would be about $2,000 in legal fees, add some moving costs and do not forget our dear old adversary mortgage penalties. Bankers love IRDs – Interest Rate Differentials – the difference between what might be paid using a higher posted rate of interest on the money borrowed, calculated over the remainder term of the mortgage and what the bank would have made if the mortgage went to full term. The IRD may be triggered by a sale or by refinancing. IRDs can run into tens of thousands of dollars and almost always come as a shock to the seller.
In this case the IRD (penalty on the mortgage) could easily be $60,000 so the apparent equity in the property drops from $200,000 to a more realistic value of about $110,000, (after notional costs) a decrease of 45%. Add to that the RRSP loan (Home Buyer Plan) $25,000 loan at 7% interest equalling a $30,000 liability. The RRSP itself is another liability, $25,000, that must be repaid over a maximum of fifteen months. When the RRSP is not paid 1/15th of the total value is added to income and taxed.
Quick Recap We started with $200,000 equity in the property less notional costs (selling costs) $30,250 = 169,750 less mortgage penalties $60,000 = $109,750 less $30,000 liability for RRSP loan = $79,750 less $25,000 RRSP repayment requirement = $54,750. In spite of the above calculations, the Government still calculates these assets at $225,000 no wonder they have such a hard time balancing budgets with magical math.