Author Topic: Canada - borrow to invest  (Read 4005 times)

Prairie Stash

  • Handlebar Stache
  • *****
  • Posts: 1796
Canada - borrow to invest
« on: February 11, 2015, 10:01:49 AM »
So my HELOC is at 3.35% now, about $250K in room. I'd like to use only $100K as a precaution, I can handle losing the money. Looking at bank stocks etc. the dividends paying out would cover all the interest on the loan. I have a decent savings rate, I could pay off the loan with time from diverting savings.

Can someone help me with figuring this out with respect to tax benefits? I'm viewing this as if I buy a bank portfolio paying out 4.5% dividends and there's no capitol gains/losses I should be up $2000/year. It seems too easy though.
 
After RRSP, splitting, deductions etc. this is my marginal tax bracket.
Income bracket                  Income    Capitol gain    CDN Dividend eligible  Non-Eligible
over $44,701 up to $89,401  35%         17.5%           12.39%                 24.29%

Thoughts? concerns? Please, this is in Canada, Canadian tax rules.

trailrated

  • Handlebar Stache
  • *****
  • Posts: 1136
  • Age: 32
  • Location: Bay Area Ca
  • a smooth sea never made a skilled sailor
Re: Canada - borrow to invest
« Reply #1 on: February 11, 2015, 10:08:17 AM »
Why put your house at risk to earn $2,000 a year or $166.67 per month?? I am sure you could ever so slightly cut back on a few things in your annual budget and save that. I would prefer to invest what I have rather than to borrow to invest, but to each their own. 

beee

  • Stubble
  • **
  • Posts: 181
  • Age: 32
  • Location: Edmonton, Canada
    • HoneyMoney.io
Re: Canada - borrow to invest
« Reply #2 on: February 11, 2015, 10:13:35 AM »
4.5% dividends? who pays that?

Prairie Stash

  • Handlebar Stache
  • *****
  • Posts: 1796
Re: Canada - borrow to invest
« Reply #3 on: February 11, 2015, 12:24:53 PM »
4.5% dividends? who pays that?
The Canadian big 5 banks are getting there again. This oil slide is wreaking havoc on their stock price but the dividends aren't affected yet.
CM - CIBC is 4.76%
RY - RBC is 4.23%

Why put your house at risk to earn $2,000 a year or $166.67 per month?? I am sure you could ever so slightly cut back on a few things in your annual budget and save that. I would prefer to invest what I have rather than to borrow to invest, but to each their own. 
Cutting back isn't an option,I've done that already. House isn't at risk, I have cash flow to cover the loan. I do invest what I have already, I forecast 2015 I'll invest another 40-50K. That's split between TFSA, RRSP and then private investment accounts; when I run out of room in tax shelters.

This is one case where you actually do want to buy exclusively dividend-paying securities because the CRA's interpretation of the law is that you can only deduct the interest if the securities distribute income.
Thank you. So ETF's are out? Hypothetically no Vanguard Canada? I'm planning on multiple bank stocks; to even out risk of one being disastrous. Last time I bought bank was in 2009, cha-ching. This was before I ever heard of SWR, I thought back then that 4% returns for life sounded pretty simple.

RichMoose

  • Pencil Stache
  • ****
  • Posts: 966
  • Location: Alberta
  • RiskManagement
    • The Rich Moose | A Better Canadian Finance Blog
Re: Canada - borrow to invest
« Reply #4 on: February 11, 2015, 12:46:04 PM »
You can invest in an ETF. As long as the security pays a dividend of some sort, it's OK. As well, the dividend doesn't necessarily have to be big enough to cover the loan interest. The only thing you want to watch out for is return of capital distributions (common with REITs), because they dilute your loan over time making an increasing portion of it non-deductible.

There's really in my opinion two main risks here.
1) When interest rates go up. This will affect how much the dividends will cover your interest payments if that's important to you (doesn't seem to be).
2) The stock loses its value so your loan goes "underwater". This is a very real risk with bank stocks right now simply because it doesn't look like they will continue to grow like they did over the last couple decades. They might even get squeezed pretty good if housing prices ever drop and people start foreclosing on their homes.

If you want to maximize your tax advantage, its probably best to choose securities or an ETF that pays lower dividends so you don't have to claim that income right now (and avoid paying that 13% tax). Remember, deferred capital gains are much better tax-wise than dividends.

I've actually been thinking of pulling a Smith Maneouvre myself, but I don't think the time is right yet. Maybe I'm just too cautious...

Prairie Stash

  • Handlebar Stache
  • *****
  • Posts: 1796
Re: Canada - borrow to invest
« Reply #5 on: February 11, 2015, 01:20:00 PM »
You can invest in an ETF. As long as the security pays a dividend of some sort, it's OK. As well, the dividend doesn't necessarily have to be big enough to cover the loan interest. The only thing you want to watch out for is return of capital distributions (common with REITs), because they dilute your loan over time making an increasing portion of it non-deductible.

There's really in my opinion two main risks here.
1) When interest rates go up. This will affect how much the dividends will cover your interest payments if that's important to you (doesn't seem to be).
2) The stock loses its value so your loan goes "underwater". This is a very real risk with bank stocks right now simply because it doesn't look like they will continue to grow like they did over the last couple decades. They might even get squeezed pretty good if housing prices ever drop and people start foreclosing on their homes.

If you want to maximize your tax advantage, its probably best to choose securities or an ETF that pays lower dividends so you don't have to claim that income right now (and avoid paying that 13% tax). Remember, deferred capital gains are much better tax-wise than dividends.

I've actually been thinking of pulling a Smith Maneouvre myself, but I don't think the time is right yet. Maybe I'm just too cautious...
Thank you Tuxedo. I guess I'm basically doing the Smith maneuver. My mortgage is almost gone already; last 10% remaining. I didn't think of it that way at first. 

I like bank stocks because they make sense to me. I've paid lots of interest, they must make a lot of money ;) Long term I see them being fine, I tend to buy, hold and forget. Securities does seem like a smarter method though. A multiyear tax plan instead of my single year planning I do now.

Interest on 100K isn't a big deal, hence the amount. A large drop will hurt short term, but it won't change my life, maybe I'll need to work one more year. If this works according to plan I'll work one year less. What's more likely, a 10 year collapse or a 10 year rise? I feel I'm too cautious also, that's why I haven't done it before now.

lostamonkey

  • Bristles
  • ***
  • Posts: 450
  • Location: Canada
Re: Canada - borrow to invest
« Reply #6 on: February 11, 2015, 01:36:23 PM »
It's not "too easy". You are risking $100K worth of equity to invest in the stock market which could easily lose 40% in the next year. It's a solid investment and will result in more wealth in the long run but it isn't risk-free. Just don't sell if the market tanks.

It's the same thing as someone who has $100K in a taxable account and has a mortgage that is >$100K except you get to deduct your interest.

GGNoob

  • Pencil Stache
  • ****
  • Posts: 726
  • Age: 33
  • Location: Colorado
Re: Canada - borrow to invest
« Reply #7 on: February 11, 2015, 01:41:16 PM »
I'm basically doing the same thing right now. I'm refinancing my house for 30 years at 3.25% interest. I'm taking nearly $40,000 cash out. Most of the money will be used to pay off debt with some going into investments. Then, since I'll free up some money in my monthly budget, I'll be able to increase my monthly savings by about $1,250 a month.

Prairie Stash

  • Handlebar Stache
  • *****
  • Posts: 1796
Re: Canada - borrow to invest
« Reply #8 on: February 11, 2015, 06:36:10 PM »
It's not "too easy". You are risking $100K worth of equity to invest in the stock market which could easily lose 40% in the next year. It's a solid investment and will result in more wealth in the long run but it isn't risk-free. Just don't sell if the market tanks.

It's the same thing as someone who has $100K in a taxable account and has a mortgage that is >$100K except you get to deduct your interest.
I already have $100K in equity invested in the market. How is this different in risk? I'm not worried about losing $40,000, I'm worried about gaining $40,000. Optimism is a friend.

It is the same thing as investing before paying off mortgage, that's true. The interest deduction is the prime benefit. I'm just concerned with making it legitimate, Tuxedo gave good advice to focus on capital gains as a better strategy. Dividends are easier for me to understand, doesn't make it the best choice.

lostamonkey

  • Bristles
  • ***
  • Posts: 450
  • Location: Canada
Re: Canada - borrow to invest
« Reply #9 on: February 11, 2015, 07:14:04 PM »
It's not "too easy". You are risking $100K worth of equity to invest in the stock market which could easily lose 40% in the next year. It's a solid investment and will result in more wealth in the long run but it isn't risk-free. Just don't sell if the market tanks.

It's the same thing as someone who has $100K in a taxable account and has a mortgage that is >$100K except you get to deduct your interest.
I already have $100K in equity invested in the market. How is this different in risk? I'm not worried about losing $40,000, I'm worried about gaining $40,000. Optimism is a friend.

It is the same thing as investing before paying off mortgage, that's true. The interest deduction is the prime benefit. I'm just concerned with making it legitimate, Tuxedo gave good advice to focus on capital gains as a better strategy. Dividends are easier for me to understand, doesn't make it the best choice.

This will result in you having an additional $100K invested which means more money at risk. I was just responding to your "too easy" comment in your first post. It's a good investment and will pay off in the long run but it isn't "too easy."

surfhb

  • Guest
Re: Canada - borrow to invest
« Reply #10 on: February 11, 2015, 07:22:54 PM »
Using the equity in your home to invest in equities?   Wow!   Just wow!