A mortgage investment pays you because a borrower pays interest on a loan secured against real property. That sentence is accurate but almost useless, because it hides everything that determines what you actually receive. The return a mortgage investment advertises and the return that reaches your account are different numbers, and the gap between them is where most of the useful information sits.
There are four places investor return can come from, and three places it leaks. This article walks all seven.
The four sources of return
1. Interest on the mortgage
This is the bulk of it. The borrower pays a coupon on the outstanding principal, usually monthly and usually interest-only on a private mortgage, because the term is short and the exit is a sale or a refinance rather than amortisation. Interest-only means the principal you have at risk does not reduce over the term — a feature, not a flaw, but worth understanding: your capital is exposed for the whole term rather than shrinking month by month.
Where the coupon sits is a function of position, loan-to-value, the marketability of the property and the length of the term. A second charge pays more than a first for a straightforward reason, covered below.
2. Lender fees
Most private mortgages carry a fee charged to the borrower at funding. Whether any of it reaches you depends entirely on the structure you have invested through, and this is a question worth asking directly. In some arrangements the lender fee is retained by the manager or the originator as compensation for finding and underwriting the deal. In others a share flows to investors. Neither is wrong, but they produce materially different outcomes on a short-term mortgage, where a fee charged once against a six-month term is a large number relative to six months of interest.
3. Renewal fees
Private mortgages are short. When a borrower renews rather than exits, a renewal fee is often charged, and the same question applies: who keeps it. On a book that renews steadily, renewal fees are a recurring revenue line rather than an occasional one.
4. Reinvestment, which is the one investors overlook
If you hold shares in a pooled vehicle and reinvest your distributions rather than taking them in cash, your return compounds. If you lend directly, your capital returns to you at the end of each term and earns nothing until it is redeployed. Over several years those two paths diverge sharply, and the divergence has nothing to do with the quality of the underlying mortgages.
The three deductions
Each of these reduces what reaches you. Taken together they frequently account for the difference between a headline yield and a disappointing bank statement.
| Deduction | What it is | What to ask |
|---|---|---|
| Management and administration | The cost of running the vehicle — underwriting, servicing, reporting, audit, and administering the mortgage. | Is the stated yield gross or net of this? Ask for the number as a percentage of assets, not of revenue. |
| Distribution costs | Commission paid to the dealer or representative who placed the investment, and any trailing fee. | Is it paid out of the vehicle or charged separately? A trailing fee reduces your return every year you hold. |
| Tax | For a Mortgage Investment Corporation, taxable dividends are treated as interest in the investor's hands rather than as dividends. | At your marginal rate, what does the stated yield become? See the worked example below. |
A worked example
Take a pooled vehicle advertising a 9% annual distribution. The 9% is a placeholder, not a Lendmax figure, and the point of the exercise is the shape of the arithmetic rather than the inputs.
- Gross coupon on the mortgages: 11%. This is what borrowers pay.
- Less management and administration, say 2%. The vehicle now distributes 9% — which is the number that gets advertised.
- Less a trailing fee of 0.5%, if one applies to your holding. You receive 8.5%.
- Less tax. At a 50% marginal rate, and with the distribution taxed as interest rather than as an eligible dividend, you keep roughly 4.25%.
The investment advertised 9% and delivered a little over 4% spendable, in a non-registered account at a high marginal rate. Nothing improper has happened — every deduction is legitimate and disclosed somewhere. But an investor comparing "9%" against a deposit product quoting its rate before tax is comparing two numbers that are not comparable, and will reach the wrong conclusion.
Why the tax treatment matters more than investors expect
A Mortgage Investment Corporation is a flow-through vehicle under section 130.1 of the Income Tax Act. The mechanism that makes it flow through also determines how you are taxed: taxable dividends other than capital gains dividends are deemed to be interest in the shareholder's hands. There is no gross-up and no dividend tax credit. A dollar of MIC distribution is taxed like a dollar of bond interest, not like a dollar of dividend from a public company.
That single fact explains why the after-tax comparison against dividend-paying equities looks worse than the headline comparison, and why holding a mortgage investment inside a registered plan changes the arithmetic so much. The registered-plan route carries its own rules and its own traps, which deserve their own treatment rather than a sentence here.
What to do with this
Three questions will tell you most of what you need to know about any mortgage investment's economics, and all three can be asked before you read a single page of an offering document.
- Is the yield you are quoting gross or net, and net of exactly what?
- Who receives the lender fee and the renewal fee?
- What does this become after tax, at my marginal rate, in the account I would hold it in?
A vehicle that answers all three plainly is telling you something about how it operates. One that cannot, or redirects to a historical return figure instead, is telling you something too.
The advertised yield is the beginning of the analysis, not the end of it. What matters is what reaches your account after the vehicle, the dealer and the Canada Revenue Agency have each taken their share.
Questions investors ask
Is the advertised yield on a mortgage investment before or after fees?
It depends on the vehicle, and you have to ask. A distribution yield is usually quoted net of management fees but before any trailing fee charged against your holding, and always before tax. Two vehicles quoting the same number can deliver materially different results.
Do I receive a share of the lender fee?
Sometimes, and sometimes not. On a short-term mortgage the lender fee is a large number relative to the interest earned over the term, so it is worth asking directly who keeps it rather than assuming.
Why is a MIC distribution taxed as interest and not as a dividend?
Because section 130.1 of the Income Tax Act deems a MIC's taxable dividends to be interest in the shareholder's hands. That is the mechanism that lets the corporation flow income through without paying tax at the corporate level. The consequence for you is full taxation at your marginal rate, with no dividend tax credit.
Does reinvesting distributions actually make much difference?
Over one year, very little. Over five or ten, a great deal — and the effect is larger in a registered plan, where there is no annual tax drag on the reinvested amount. The difference comes from compounding, not from the mortgages performing better.
Is a higher yield simply a better investment?
No. In this asset class a higher coupon generally reflects additional risk — a weaker position, a higher loan-to-value, a less marketable property, or a borrower an institutional lender declined. The yield is the price of that risk, not a free gain.