Making Your Mortgage Work For You: Home Equity Loan for Investment
This approach is not quite the Smith Maneuver that I blogged about earlier this week, but does allow you to bank on the equity in your home to get more invested in the stock market. It also lets you deduct the interest of that loan.
In effect, you use your home as collateral. That's what a home equity loan is. In this case, rather than getting a home equity loan and then putting on that addition or renovating the basement, you take that money and put it in the stock market. Be sure to purchase good quality investment vehicles, since any losses here will put you in the position of paying off the loan, without investment that's worth at least the original value of the loan.
You may have to look outside of your regular lender to get a loan like this. You may also have to pay a higher interest rate than you do on your conventional mortgage. That's one of the downfalls of the approach. The advantage is that you can decide exactly how much loan you want and can custom design a combination of mortgage and investment loan that you can handle on your income stream.
Given that loans for investments are tax deductible, you will get a tax deduction on this loan. (This can help with the bite of the higher interest rate.) You can either pay off the loan completely over time, and fully retain the investment, or at some point you can cash in your investment to pay off the loan, and have some profit left over. (At least, that's the theory!)
This is less risky that the Smith Maneuver and the re-advanceable mortgage, because you pick the amount of loan that you think you can handle, including the loan payments, and you only risk this limited amount in the stock market. You get a tax break too, which you don't get if you hold your mortgage inside your RRSP. The loan itself is secured by your home, so you can potentially roll this debt into your mortgage, if the unthinkable happens and you lose your shirt. And, as long as you haven't negotiated too big a loan, you will retain the ownership of your home, even if you do have a problem.
Always ensure that you are borrowing a percentage of your equity that will allow the value of your home to float down at least 20 percent, without jeopardizing your ability to use your home as collateral on the loan. As we've seen recently, even the housing market is prone to rising and falling, if the foreclosures currently predicted are any indication.
Given the tax laws in both Canada and the US, it should work in both countries. In the US, there are deductions that are allowed for home equity indebtedness. In Canada, there are deductions allowed for investment purposes. But, as with all investing, you need to know if it is right for you. Consult an investment professional if you are thinking about a home equity loan for investment purposes. Not only can they help you determine amounts to borrow and help you find potential lenders, they can also help find the right investment mix for your money.