Canadians typically consider mortgages as a burden, to be paid down as quickly as possible, or at least before retirement.
It may seem counter-intuitive, but for the wealthy, mortgages are a tool to make more money.
Carrying a mortgage when you don’t need one might seem like a head-scratcher. Why borrow when you’ve already got plenty of funds at hand?
But as F. Scott Fitzgerald purportedly once said, “The rich are different from you and me.”
It sometimes makes sense for high-net-worth people to take on new debt, says James Robinson, mortgage agent at Dominion Lending Centres in Toronto.
“Using your real estate holdings to borrow money for investment purposes – either your principal residence or any other investment or personal-use property – falls under the ‘wealthy people become wealthy by using other people’s money’ category,’” Mr. Robinson says.
“If you can invest at a higher rate of return than you can borrow, you will increase your wealth and, therefore, your net worth.”
There are also tax advantages, though Mr. Robinson advises investors to seek professional advice about tax implications. In Canada, mortgage interest is not tax deductible; however, the interest paid on funds borrowed for investment is, so borrowing has to be structured carefully to avoid running afoul of the Canada Revenue Agency.
Remortgaging or taking a line of credit secured against property can also be advantageous for investors who are affluent but don’t quite reach the high-net-worth (HNW) category.
Financial institutions generally consider HNWs to be people with $1-million in liquid assets, while those with $100,000 to $1-million are considered “affluent” or “sub-HNW.”
One reason that HNW clients can consider taking on a mortgage is that “normally, they’re the ones who have access to assets for security [their houses and other properties] as well as the income required to service the debt,” says Paul Shelestowsky, senior wealth advisor at Meridian Credit Union in Niagara-on-the-Lake, Ont.
For those who are barely at the HNW threshold but want to boost their investable assets, “unless you can obtain a preferred rate from your lender, using secured debt is the only advisable way to borrow to invest,” Mr. Shelestowsky says.
Mr. Robinson cites several good ways to borrow to invest.
“The most common strategy used is to simply refinance your principal residence to access some of the equity you have built up over the years, and use the additional funds to purchase an investment property,” he says.
Wealthy borrowers who refinance in this way increase their asset base through leveraging, but this also is contingent on the value of real estate going up, Mr. Robinson adds.
“If you own $600,000 worth of real estate and prices rise by 5 per cent, you have increased your worth by $30,000. If you leverage and now own $1.2 million worth of real estate and prices rise by 5 per cent, you have increased your worth by $60,000.”
What could possibly go wrong? A few big things, the experts say.
For one, it’s never certain that the value of real estate will rise. There’s always the risk that you will be paying off a mortgage on a property whose value is drifting sideways, or even dropping. This could be happening, too, as your market investments are nosediving.
“Remember that when you leverage and asset values fall, the same multiplying effect occurs in the opposite direction. Don’t get caught in a get-poor-quick scheme,” Mr. Robinson says.
Real estate values do tend to go up over time, but it is not a straight line, he adds. In Ontario and other parts of Canada, the years from 1989 to 1996 were brutal for real estate values.
Debt-holders must be patient, says Andrea Thompson, senior financial planner with Coleman Wealth, part of Raymond James Ltd. in Toronto. “Investors must be able and willing to sit with a paper loss and continue to collect the monthly income, rather than panic and sell at a loss.”
Investors considering taking a mortgage should also be mindful of rising interest rates. The Bank of Canada is holding the line on rates for now, but it has hiked its key lending rate three times since last July, Ms. Thompson says.
High-net-worth borrowers also should consider the type of mortgage. “Looking at a variable rate or open mortgage might be preferable to some who want more flexibility, if they want to collapse or modify their strategy if and when interest rates rise,” Ms. Thompson says.
A different way to go, Mr. Robinson says, is to take what some lenders now offer as an “all in one” borrowing product, secured by real estate.
“This combines a mortgage with a home equity line of credit to allow you excellent flexibility in your borrowing as well as the ability to keep your borrowing segmented for interest calculation and tax deductability,” he explains.
Even the wealthy should be cautious in this volatile investment climate, Mr. Shelestowsky says.
“An overarching theme from the investment world is ‘lowered return expectations’ going forward,” he says. “Target expectations have been drastically reduced across all investor profiles.”