Tax Deductible Mortgage Strategy

To Pay Your Mortgage Down Faster and Build an Investment Fund

How Does this Tax Deductible Mortgage Strategy Work?

The Tax Deductible Mortgage Strategy is a way for Canadians to make their mortgage interest tax-deductible. While Americans can already claim their mortgage interest on their tax returns, this strategy lets Canadians achieve a similar benefit.

Here’s how it works: In Canada, if you borrow money to invest in income-producing assets like stocks or rental properties, you can deduct the interest on that loan from your income taxes. With this strategy, you borrow against the equity in your home, invest that money in income-generating assets, and then use your tax return to pay down your mortgage.

Repeat this process over time, and you’ll eventually turn your mortgage debt into a tax-deductible investment loan, all while building a larger investment portfolio.

This strategy uses a unique mortgage product called a re-advanceable mortgage. It’s a mortgage and Line of Credit product that when you pay your mortgage payment, the line of credit grows in size. This allows you to borrow more to invest.

In a nutshell, the Tax Deductible Mortgage Strategy helps you pay off your mortgage faster, save money on taxes, and grow your investments for the long term.

Should I use the Tax Deductible Mortgage Strategy?

Advantages:

  • Build an Investment Portfolio Early: Start growing your investment portfolio right away without waiting to pay off your mortgage first, harnessing the power of compounding.
  • Pay Down Your Mortgage Faster: Use the strategy to accelerate your mortgage payments and reduce non-deductible debt.
  • Tax-Deductible Investment Loan: Turn your new investment loan into a tax-deductible asset, especially valuable for those in higher tax brackets.

Downsides:

  • Comfort with Leverage: You need to be comfortable with borrowing (leverage) and investing.
  • Have a Backup Plan: Be prepared with a backup plan in case you need to move and home values have dropped. A well-invested portfolio should cover the loan at a minimum.
  • Record-Keeping: Keep track of your investment loan details for tax purposes.

What are the Benefits of the Tax Deductible Mortgage Strategy?

Meet Alex and Taylor, a couple living in Alberta with big plans for their financial future. They recently bought a home valued at $600,000 and have a mortgage balance of $400,000 at a 5.5% interest rate over a 27-year amortization period. With a household income of $120,000, Alex and Taylor want to pay off their mortgage faster and grow their investments. That’s where the Tax Deductible Mortgage Strategy comes in.

The Strategy in Action:

  1. Opening a HELOC: Alex and Taylor open a Home Equity Line of Credit (HELOC) with a 7.7% interest rate. This allows them to borrow against their home equity, giving them access to funds they can invest.
  2. Making the Investment: They borrow $100,000 through the HELOC to invest in a portfolio that offers an 8% annual return paid out in monthly dividends. This means they earn $8,000 annually, or about $667 per month, from their investment.
  3. Paying Down the Mortgage: They use the $667 in dividends to pay the HELOC’s interest and then pay down their mortgage balance. This reduces their principal faster and saves on non-deductible interest.
  4. Tax Deductible Interest: The interest on their HELOC loan is tax-deductible since the borrowed funds are invested in income-producing assets. This provides additional tax savings on their annual income.

The Result:

Net Worth Improvement

By sticking with the Tax Deductible Mortgage Strategy they’ll have a projected investment portfolio of $787,891.30, based on an investment return of 8%. They’ll also have a fully tax deductible investment loan of $390,000.00. Their net worth improvement would be $397,891.30.

Years Saved

By using this mortgage strategy, they’ll pay off their mortgage by year 19 and month 7. This means paying off the 27-year mortgage faster by 7 years and 5 months.

What are the cons of the Tax Deductible Mortgage Strategy?

While the Tax Deductible Mortgage Strategy can offer significant benefits, it’s important to be aware of the potential drawbacks. Here’s a closer look at the cons:

  1. Investment Returns Must Outperform HELOC Interest:
    • The strategy hinges on achieving investment returns greater than the HELOC interest rate. For example, if your HELOC charges 7.7% and you’re in a 40% tax bracket, your effective interest rate is 4.62% after the tax deduction. Your investments need to consistently exceed this rate for the strategy to work.
    • Historically, North American stock markets have averaged over 10% annually, but this isn’t guaranteed.
  2. You Need at Least 20% equity in your property (i.e. 80% Loan to Value Ratio):
    • The readvanceable mortgage product is only available for conventional financing. Therefore your mortgage can’t be above 80% of the property value.
    • If you are buying a property and are putting in less than 20%, you may need to wait until there is more equity in the property before starting this tax deductible strategy.
  3. Increased Risk Exposure:
    • Some see the strategy as too risky since you’re borrowing against your home to invest in the stock market. Market downturns can affect your investment value, potentially impacting your ability to pay off the HELOC.
    • If you need to move and home values have dropped, your portfolio must at least cover the loan amount.
  4. Comfort with Leverage:
    • Using leverage (borrowing to invest) isn’t for everyone. You need to be comfortable with the idea of taking on additional debt to grow your investment portfolio.
  5. Record-Keeping and Compliance:
    • The strategy requires meticulous record-keeping for tax purposes. You’ll need to carefully track your investment loan interest and ensure the funds are only used for income-producing assets.
  6. Time and Effort:
    • Properly implementing the strategy requires time and effort, including regular monitoring of your investments and HELOC payments.

If you’d like to see how powerful this strategy will be for you, let’s jump on a call!

I’ll walk you through the costs, returns, and steps for your personal scenario.

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