In my last blog, I spoke about borrowing against your home to turbo-charge your retirement savings. I went through some of the conditions you want to have in place and the mechanics of the strategy. In this post, I’ll go through some of the pitfalls you want to watch out for if you do decide to go ahead with this strategy.
HELOC or Fixed Rate Mortgage?
So, you’re ready to pull the trigger and implement the strategy. What decisions do you need to make first, and what do you need to know?
You first need to decide what kind of loan to take. Do you want a Home Equity Line of Credit or a fixed rate mortgage? Well, there are advantages and disadvantages to both. A Home Equity Line of Credit allows you to unwind the strategy at any time, without penalty. On the other hand, you’re exposed to potentially rising interest rates. With a fixed rate mortgage, say for a 5-year term, you lock in your interest rate, but you might have to unwind the portfolio at a specific point in time, in other words, at the maturity of the mortgage, which may not be the best time to sell the investments.
That said, I prefer the fixed rate option for two reasons. First, interest rates are generally rising and bond market expectations are for this to continue gradually over the next few years. Second, you can always roll the mortgage into a home equity line of credit when it matures if you don’t want to unwind the portfolio at that particular time. You could even roll it into another fixed rate mortgage if the interest rates are low enough to make that interesting.
Where to Invest Your Loan Funds
You’ll also need to decide how to invest the proceeds of the loan. How much risk do you want to take with these funds? You can’t simply buy a portfolio of bonds because you won’t make much more than the interest you’re paying on the debt. You also probably don’t want to buy an all-stock portfolio, because the potential of a serious market drop would be pretty nerve-rattling in relation to the amount you owe on the debt. The final decision lies somewhere in-between and it will be a function of what other investments you may have and the level your income relative to the cost of the debt.
Things to Consider Before Borrowing to Invest
There are a few more caveats to doing this, and it’s important that you go into it eyes wide open, so here they are:
- Don’t put the proceeds of the loan into your TFSA or RRSP. If you do that, you can’t deduct the interest from your income on your tax return. I’m generally not in favor of borrowing to invest in your RRSP or TFSAs no matter what the banks say.
- Don’t use the loan for anything but investing. For instance, if you borrow $100,000, don’t put $50,000 in your portfolio and use $50,000 to renovate. From Canada Revenue Agency’s perspective, that muddies the water when you deduct the interest on your taxes. Keep the loan for investing and nothing else.
- As I mentioned several times in my previous video, don’t borrow so much that a rise in interest rates and a drop-in stock markets would squeeze your ability to make the payments on the loan. You don’t want to be forced to collapse this strategy at the wrong time.
I hope all this has given you food for thought on how to leverage your home to turbo-charge your retirement savings.