Making Money with Your Mortgage

Let's say you get a home equity line of credit for $300,000 (75% of a $400,000 house). Take the money out and put into low fee equity based index funds (you can use mutual funds if you like but I hate them). You will be making interest only payments on the line of credits. Because the money is being used to buy investments, the interest is tax deductible. Still you will need to come up with the $1,500 interest payments each month. How do you do that?

The Systematic Withdrawal Plan

Have your financial planner set up a systematic withdrawal plan (SWP) from your index fund to cover the monthly interest payments on the home equity line of credit. Now the fund is actually making the loan payments, rather than you. But every year when you fill out your tax return, you'll be able to deduct the $18,000 of interest off your taxes! That will trigger a $9,000 tax refund if you're in the top tax bracket.

Despite the fact you have removed money through the systematic withdrawal plan to cover all interest charges, the index fund should give you substantial capital growth. It doesn't even have to grow 6% per year in order for you to be ahead because of the deductible interest. This is a win-win situation: you're leveraging your house with a fully deductible mortgage and you're using a systematic withdrawal plan so no money comes out of your pocket for financing.

What if you borrow against your home, and buy index funds that decline in value? Don't worry about it. Unless history is no guide, equity investments increase in value over the long haul. Of course, there are years when markets decline, but they are far outnumbered by years of gains. As long as your investment performs at a rate that exceeds your withdrawal rate, your investment will continue to grow. This is not a short term investment. You will be holding it for a long time (min 5 years), the longer the better. As a matter of fact you may want to increase the size of the line of credit as the value on your house goes up so you can buy more and get an even bigger tax deduction!

The above strategy can be done even if you don't have a free and clear house. Banks will lend up to 75% on a home equity line of credit. So if you already have 50% equity in your house you can get a home equity line for the remaining 25% and increase it as your home mortgage gets paid down (Smith Manoeuvre).

This is how you built real wealth. Creating wealth by saving your pennies is a really slow and painful way to do it. If you want to get rich, you have to use a lot of leverage and get heavy into debt. Just make sure it's good debt!

This post will help illustrate the power of the home equity line of credit and systematic withdrawal plan (SWP) strategy. Bob has a fully paid for house – its current value is $400,000. After reading my blog, Bob decides that having all his assets tied up in his house is not the smartest thing to do so he goes to his bank and gets a $300,000 home equity line of credit and invests the proceeds in equity index funds. At the same time he set ups a systematic withdrawal plan to pay the monthly interest cost.

Before we continue, let's make a few assumptions – interest on the line of credit is at prime, which is currently 6%. The index funds perform at 10% per year. That is the average return the TSX index has produced in the past 50 years. Yes there were years when the returns were less than 10% (or negative) and there were years when the returns were well above 10%. But the overall average for the past 50 years is 10%. If you are going to do this strategy, you must be willing to go at least 5 years to ride out any market downturn.

Let's say it's 5 years later. Bob looks at his portfolio to check out how it's doing. This is what his portfolio will look like.

Even though Bob had $18,000 taken out of the funds every year to pay the interest on the line of credit, the ending balance of his funds after 5 years is up over $70,000. In addition to that, Bob has been getting huge tax refunds every year because he was able to deduct the interest on the line of credit, which was paid by the SWP and not him. If Bob was in the 40% tax bracket he would get back $7,200 each year that he can use to buy more index funds. Then the numbers would look like this.

In five years Bob has been able to increase his assets outside of his home by over $100,000 and not a single penny came from his pocket. The longer Bob keeps this going, the better the numbers become. If Bobs goes for another 5 years, the value of the funds would increase to nearly $590,000. This is the power of compound interest. The longer you leave it in, the more you will make. In 20 years, the funds will be worth nearly $1.36 million. If Bob closed out the investment at that time, he would repay the $300,000 to the line of credit and have $1.06 million left over, plus a free and clear house. A pretty good way to retire, huh? Much better than just a clear title house and no money.

The beauty of this strategy is absolutely no money comes from your pocket. You are leveraging the equity in your home to make you money. To match Bob's investment return of $1.06 million in 20 years with normal out of your pocket investing, you would need to invest $16,800 every year for the next 20 years (assuming the same 10% return). How many people can sock away $16K a year into investments? Yet, this strategy allows you to get the same results without ever having to reach into your wallet. If you have a lot of equity in your house, it's time to put it to work and turn your home into a money train!

As always, please consult a qualified financial planner before proceeding with any strategies I give on this blog.

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