Canadian real estate purchasing strategy to deduct interest costs
Question: I have a liquid net worth of 400k, generally invested in a diversified group of equities, bonds, and PM funds (fully paid for; ie. no margin used yet). I’m planning on purchasing a $150k propert, putting 25% as a downpayment, and was originally considering putting the rest on a 25-year mortgage without touching my investment portfolio – basically I’d pay ~690 per month @4.8% for a 25year mortgage (interest payments would originally cost roughly $475/month). In Canada, the mortgage interest payments aren’t tax-deductible, but the interest payments on one’s investment account (nonRSP) are deductible. So I thought of an alternate strategy, which would be to take out roughly 120k as borrowed cash from my investment portfolio (ie. not sell any of my securities) and thus use that as a margin loan for the remainder of the portfolio, and apply the 120k towards the house. This way, instead of paying interest on a mortgage loan, I’d pay margin interest instead, which should be fully deductible. The current margin interest rate is 4.72%. Does this strategy make sense? I don’t think I’d be taking on extra risk, since the net cash and equity position would remain the same, except the the loan would be coming from the brokerage firm instead of a mortgage lender. I calculated that the net savings would be roughly 2300 in the first year (assuming 40% tax rate).
One concern would be interest rate risk; if rates were to rise, the margin interest paymetns would go up. But would it be possible to hedge that by buying or selling an interest rate futures contract?
Answer: You should probably consult a lawyer about that. Here is how I think it works (but I’m not an expert on this). It doesn’t matter whether your loan is from the bank or a margin loan from your stock broker. What is important is what the money is used for. So if you borrow on margin from your broker and use the money to pay the mortgage, then the loan wasn’t used for investment it was used to pay another debt and interest is not deductible. What you could do is sell $120k of equity, pay the mortgage then go to the bank and get another $120k loan (you can mortgage your house to get a better interest rate on this new loan) and this time the loan isn’t used to buy a house (you already own your house) it is used to buy $120k worth of equity from your broker so interest are deductible.
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