Author Topic: RRSP-LOAN The Good, The Bad, The Ugly,  (Read 716 times)

Swish

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RRSP-LOAN The Good, The Bad, The Ugly,
« on: May 14, 2018, 05:06:12 PM »
I have a dilemma where I am unsure whether or not to purchase spousal RRSP. I currently have a tight monthly budget outlined in the following case:

Case Study - 32 Looking for advice on FIRE since career change
https://forum.mrmoneymustache.com/case-studies/find-my-sacred-cow!-lets-make-burgers!/

What I am wondering is if it makes sense to finance a Spousal RRSP loan for $27k at 2.7% on a 15 year open term. My accountant said that I will get a tax refund of approximately $9K which I could then use to pay down debt or put in an account to make the payments on the loan for a number of years or just invest it. As pointed out I am already carrying a fair bit of leverage.

The rebate makes sense to me in light of the low interest and payments but I am wondering if the consensus would be to wait a few years until my debt is paid down forgoing potential growth. If so How many years out should I be working this into the plan?

RichMoose

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #1 on: May 14, 2018, 10:32:38 PM »
Probably not worthwhile. Your income is under $92k where the tax rates jump. Plus, based on your case study you have a leverage problem. I don't see how carrying more debt which is not tax deductible helps your situation.

If I were in your shoes I would chip away at your debt, try reduce your non tax deductible debt as fast as possible, and maybe consider selling one or more of your properties to diversify and deleverage.

Swish

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #2 on: May 15, 2018, 11:08:19 AM »
Thanks for the response @RichMoose

Currently My personal home and an existing RRSP loan are my two largest non deductible debt. Would you recommend the home or the RRSP loan first or does it really matter as they have similar interest rates/terms (2.59% and 2.7% on approx 15yrs)?

If I am trying to FI/RE in the next ten years at what point should I start shifting from debt reduction to maximizing out my RRSP contribution room?

RichMoose

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #3 on: May 16, 2018, 01:25:41 PM »
Thanks for the response @RichMoose

Currently My personal home and an existing RRSP loan are my two largest non deductible debt. Would you recommend the home or the RRSP loan first or does it really matter as they have similar interest rates/terms (2.59% and 2.7% on approx 15yrs)?

If I am trying to FI/RE in the next ten years at what point should I start shifting from debt reduction to maximizing out my RRSP contribution room?
Regarding the loan question, I would aggressively tackle the higher interest debt first. A 15 yr RRSP loan (also the higher interest one) is crazy. You save some taxes in, you pay non-deductible interest along the way for a long time increasing the real cost of the contribution, then you pay tax on the way out. It doesn't make a whole lot of sense, particularly when you have assets which can take on tax deductible loans.

On the second question: Looking at the information your case study provides, there is a clear direction of high debt -> high assets -> moderate returns. That embeds a massive amount of risk into the equation. If everything ticks along in a continuous upward trajectory things will work out well, if not your situation could be a ticking time bomb.

In my view you are too highly leveraged in low productive assets. Not including depreciation on real estate is a big mistake. Calculating leveraged returns is also a big mistake. It makes me think you might have been bamboozled a bit by REIN and some of the similar groups.

I think you should seriously consider getting rid of one or two of your least productive properties. Use the proceeds to get your non-deductible debt down to a minimum. Keep the loan amount high on the remaining rental property(ies) and pay down your home mortgage according to the normal schedule. Then start making the most of RRSP and TFSA room from your normal cash flows.

Swish

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #4 on: May 16, 2018, 01:36:23 PM »
In my view you are too highly leveraged in low productive assets. Not including depreciation on real estate is a big mistake. Calculating leveraged returns is also a big mistake. It makes me think you might have been bamboozled a bit by REIN and some of the similar groups.

Why do you view not depreciating as a mistake? Typically the housing market appreciates and if I realize depreciation too early I will create a capital gain once I finally sell the asset. Are you saying this as the plan should be to hold the house indefinitely thereby never paying the gain against the depreciation schedule? What is an appropriate % to depreciate real estate against that you use?

RichMoose

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #5 on: May 16, 2018, 01:47:54 PM »
In my view you are too highly leveraged in low productive assets. Not including depreciation on real estate is a big mistake. Calculating leveraged returns is also a big mistake. It makes me think you might have been bamboozled a bit by REIN and some of the similar groups.

Why do you view not depreciating as a mistake? Typically the housing market appreciates and if I realize depreciation too early I will create a capital gain once I finally sell the asset. Are you saying this as the plan should be to hold the house indefinitely thereby never paying the gain against the depreciation schedule? What is an appropriate % to depreciate real estate against that you use?

I'm not questioning how your CPA recommends you file your taxes. Maybe a better way to phrase the point is not to discount the real costs of owning rental real estate. In your monthly cash flow / return figures, how are you accounting for repainting, redoing flooring, replacing windows, replacing cabinetry and countertops, roofing, driveway repair, landscaping and fencing, furnace and HWT, and so on. Also, vacancy cost and other forms of lost rent (stubborn bad tenant stuff).

Swish

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #6 on: May 17, 2018, 10:10:08 AM »

Maybe a better way to phrase the point is not to discount the real costs of owning rental real estate. In your monthly cash flow / return figures, how are you accounting for repainting, redoing flooring, replacing windows, replacing cabinetry and countertops, roofing, driveway repair, landscaping and fencing, furnace and HWT, and so on. Also, vacancy cost and other forms of lost rent (stubborn bad tenant stuff).

I see what you mean now. The way I currently have been tracking these is realizing them as an expense. I am lucky to have purchased homes where most of the big ticket items have been taken care of and should be good for a long time. The smaller stuff like repairs/paint/vacancies I count as an expense against the rent collected and yes I should add that cost into my return calculation. In my budget I assume 80% vacancy and track the dollar amount as an expense and then realize an increased income if I do not have a vacancy during the year. Although this is probably too conservative as our area has hovered around 2-3% for 15+ years.

RichMoose

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #7 on: May 17, 2018, 12:10:07 PM »

Maybe a better way to phrase the point is not to discount the real costs of owning rental real estate. In your monthly cash flow / return figures, how are you accounting for repainting, redoing flooring, replacing windows, replacing cabinetry and countertops, roofing, driveway repair, landscaping and fencing, furnace and HWT, and so on. Also, vacancy cost and other forms of lost rent (stubborn bad tenant stuff).

I see what you mean now. The way I currently have been tracking these is realizing them as an expense. I am lucky to have purchased homes where most of the big ticket items have been taken care of and should be good for a long time. The smaller stuff like repairs/paint/vacancies I count as an expense against the rent collected and yes I should add that cost into my return calculation. In my budget I assume 80% vacancy and track the dollar amount as an expense and then realize an increased income if I do not have a vacancy during the year. Although this is probably too conservative as our area has hovered around 2-3% for 15+ years.
Yes, the way you are accounting for these costs is quite common with amateur landlords. The problem is that it distorts the real investment return picture over the long term. It also has drastically inflated the valuations of rental property because so many people are being drawn into the landlord game based on flawed math.

For example, if you own a property worth $250,000 and collect $1,500 a month in rent, I see lots of people quickly say their property has a 7.2% yield. Then they'll say that there's a $200,000 mortgage with a $5,000 annual interest expense, so their yield on their equity is 26%. And that does a quick leap to say that there is no other investment that can give a 26% yield plus capital gains over time. Therefore landlording is awesome. (Not saying this is you exactly, I realize you are at least figuring taxes, vacancy, and some other costs).

However, the more correct way to look at it is calculating the true cost of the depreciation of each component of the property in real time. Even if the house is new or recently renovated, the costs are still very real even if the cash might not be out tomorrow. So on the same example property, the following is much more realistic and the costs are probably still understated:

House: $250,000
Mortgage: $200,000 @ 2.5%
Equity: $50,000

Rental Income: $1,500
Interest Expense: $417
Property Tax: $180
Insurance: $150
Municipal Utilities: $75
Paint (5 yr life): $20
HWT (10 yr life): $5
Floor (15 yr life): $50
Furnace (20 yr life): $18
Cabinet/Counters (30 yr life): $40
Light/Plumbing Fixtures (30 yr life): $8
Deck/Fence/Landscape/Driveway: $50
Siding (30 yr life): $25
Windows & Doors (30 yr life): $35
Ancillary Damage (pests/mold/cleaning/water): $50
Vacancy Cost 5%: $75
TOTAL Expense: $1,198
NET INCOME: $302  or 1.45% yield on assets or 7.25% yield on equity
Now that number doesn't include investment/income taxes, real agent fees, lawyer fees, purchase/sale taxes, increased interest potential, and probably a bunch of other stuff I'm not thinking about off the top of my head.

I'm suggesting you take a good look at each of your rental properties and get a true idea of your real returns. Sell your worst ones and keep the best one or two if you really are determined to be a landlord. Looking at your financial picture in your CS, you are very highly leveraged and probably dangerously so. I think your whole plan is based on one hope: that your local property market explodes upwards in value. Adding more leverage to invest, whether that's your RRSP, or borrowing to improve rental properties, or buying naked options is not a sound, broadly diversified, likely to succeed strategy.

Swish

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #8 on: May 17, 2018, 03:23:49 PM »
@RichMoose Thanks this makes a lot of sense. Seems I have a fair bit of homework to assess the value of components. Like any curve there is probably an optimal point at which to sell the asset. This is how we currently realize depreciation for investments at work on assets so why would I do it differently considering my personal investments?

Sadly the honest plan with the rentals wasn't so sophisticated. It was just to get rid of the debt and live on the rental income. Housing market in my town only appreciates on average 2% per year. One spike in 2007 of 15%ish but other than that it has stayed pretty consistent. Basically we got a rental because I went back to school and couldn't afford our mortgage anymore. Every one said sell it rent till you are done school. Instead I went to the bank and some how got approved to buy a second home with a much lower payment schedule. We moved there while I finished school and rented the original home. Then once I got a higher paying career we bought a nicer home and rented out the other one. Bank offered really low interest rates if we increased our principle payments and locked in til 2021. At the time on the higher wage it was pretty easy to cover the extra fixed commitment. I was working longer and longer days and home life was struggling so I took a role with a lot less responsibility and better holidays/pension. Right now it has been fairly stressful trying to hit the fixed commitments but I can honestly say that is the only significant source of stress. Otherwise the job change has been pretty healthy.


Adding more leverage to invest, whether that's your RRSP, or borrowing to improve rental properties, or buying naked options is not a sound, broadly diversified, likely to succeed strategy.
True,
To be fair though, the options I have were actually married puts/covered calls prior to Monday not just the pure speculation they are now. I sold after taking a well deserved facepunch on the case. Ex I had 1500 shares of HDSN but R22 coolant was selling for $14 instead of $22 like last year so I couldn't see a feasible way they could hit their earnings estimate as their costs had not decreased. So I bought 30 puts @ 4.00 a few weeks ago to protect my long position. I am comfortable trading but at this point given my cash flow and leverage it seems stupid to risk money I need to get to FI/RE when I can just correct course. I do not need to assume so much risk to achieve my goals. Once my TFSA's RRSP's & Debt are fixed I will have plenty of time to save up some cash to play stock analyst with while keeping the base safe.
« Last Edit: May 17, 2018, 03:27:20 PM by Swish »

RichMoose

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #9 on: May 17, 2018, 04:27:10 PM »
@RichMoose Thanks this makes a lot of sense. Seems I have a fair bit of homework to assess the value of components. Like any curve there is probably an optimal point at which to sell the asset. This is how we currently realize depreciation for investments at work on assets so why would I do it differently considering my personal investments?

Sadly the honest plan with the rentals wasn't so sophisticated. It was just to get rid of the debt and live on the rental income. Housing market in my town only appreciates on average 2% per year. One spike in 2007 of 15%ish but other than that it has stayed pretty consistent. Basically we got a rental because I went back to school and couldn't afford our mortgage anymore. Every one said sell it rent till you are done school. Instead I went to the bank and some how got approved to buy a second home with a much lower payment schedule. We moved there while I finished school and rented the original home. Then once I got a higher paying career we bought a nicer home and rented out the other one. Bank offered really low interest rates if we increased our principle payments and locked in til 2021. At the time on the higher wage it was pretty easy to cover the extra fixed commitment. I was working longer and longer days and home life was struggling so I took a role with a lot less responsibility and better holidays/pension. Right now it has been fairly stressful trying to hit the fixed commitments but I can honestly say that is the only significant source of stress. Otherwise the job change has been pretty healthy.


Adding more leverage to invest, whether that's your RRSP, or borrowing to improve rental properties, or buying naked options is not a sound, broadly diversified, likely to succeed strategy.
True,
To be fair though, the options I have were actually married puts/covered calls prior to Monday not just the pure speculation they are now. I sold after taking a well deserved facepunch on the case. Ex I had 1500 shares of HDSN but R22 coolant was selling for $14 instead of $22 like last year so I couldn't see a feasible way they could hit their earnings estimate as their costs had not decreased. So I bought 30 puts @ 4.00 a few weeks ago to protect my long position. I am comfortable trading but at this point given my cash flow and leverage it seems stupid to risk money I need to get to FI/RE when I can just correct course. I do not need to assume so much risk to achieve my goals. Once my TFSA's RRSP's & Debt are fixed I will have plenty of time to save up some cash to play stock analyst with while keeping the base safe.
Sorry, I realize I'm being a bit face-punchy. You're definitely not the first and won't be the last person to fall into the landlord game based on prompting and enabling from family, real estate agents, the banks, etc.

On the bright side, your puts are way in the money! A nice gain of a few grand in a couple weeks.

Swish

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Re: RRSP-LOAN The Good, The Bad, The Ugly,
« Reply #10 on: May 20, 2018, 11:36:58 PM »
@RichMoose some facepunching is to be expected. I am not on the internet asking for advice because things are going perfectly smooth :)

Ya it was a good buy. Completely offset the loss on the long position and cleared a few grand. I don't get them all right but the options really help limit the downside risk for a relatively small premium.
« Last Edit: May 20, 2018, 11:39:32 PM by Swish »