Taking Out a Loan to Fund Your TFSA
In order to maximize your TFSA contributions, it may actually make sense for you to take out a loan. While you could theoretically do this with your credit card (with the associated high interest rates…not a good idea!), most people seeking to borrow money for their TFSA take out a secured loan from their bank or credit union, using some asset such as their house or car as collateral.
Before loaning you money, your bank or credit union will want to make sure you will pay it back plus the agreed-upon interest. You’ll need a good credit history and may need to provide some documentation from your employer and other creditors. And make sure to specify the loan is to contribute to your TFSA and isn’t a car, student, or business loan..these type of loans have different lending criteria and rates.
How much can you borrow?
Generally your financial institution won’t lend you more than your contribution limit; anything more and they will ask what you plan to do with the excess and probably suggest separate loans at that point. So if, for example, you have $10,000 of unused contribution room, you can theoretically borrow up to $10,000. However there may be a bank-imposed limit on loans regardless of your contribution limit. For most banks this is $50,000.
Whatever amount you decide to borrow, make sure you can afford to repay it within the loan term! If you default on the loan it will affect your future credit rating, can raise your insurance premiums, and affect your ability to find employment. In addition, the collateral you used to get the loan in the first place may be seized and you could be out of a home, car, or other assets.
Loan interest rates
One of the biggest factors to consider is the interest you’ll be paying on your TFSA loan. When taking out a loan you’ll be offered the choice between a fixed interest rate or an adjustable interest rate:
- Fixed-rate loans are best if you plan on making consistent monthly payments over the longer term and prefer the predictability that a fixed rate allows. If you qualify for a low interest rate or think rates will rise and want to lock in your rate now, go for a fixed-rate loan.
- Adjustable (variable)-rate loans are best if you plan to pay off the loan over a shorter period and think rates will fall during the loan term. The rate is tied to market conditions and the prime lending rate so do your homework if you want to go this route.
Your interest rate will depend on your creditworthiness and how much you are borrowing. If you are an excellent candidate you may be offered the financial institution’s “prime rate” (currently around 6%). But most people will be offered somewhere around prime + 1-2%.
This is how long you have to repay your TFSA loan. Each bank or credit union has their own repayment term; these can range from 1 to 15 years. Other details such as deferring payments, repaying early, and any penalties for doing either are usually spelled out in the fine print…make sure to read it!
Can a TFSA be used as collateral for a loan or is this restricted?
Yes, it is permissible to use your TFSA as collateral for a loan. However, depending on what your TFSA is invested in (bonds, GICs, stocks, cash, etc.), and the risk level associated with each of these, the lending institution may or may not consider the value of your TFSA at its current full market valuation. That is, if you’re invested in things that are very risky for instance, due to market fluctuations, your TFSA portfolio may only be valued at a fraction of what it’s currently worth. Cash, GICs, and low risk bonds should be recognized at their full current value.