For the majority of Canadians, we start our investing journey with saving up a sufficient downpayment to buy our first home. If you’re lucky, you might be able to secure a mortgage with a very low down payment. Over time, we pay down our mortgage. Our properties appreciate in value.
Some people choose to pay off their mortgage as quickly as possible, hoping to live a mortgage free life.
If you are inspired to pay down your mortgage as quickly as possible and live a debt free life by all means go for it. But if I were Sean, living mortgage free on my home would only be my first step.
Now that I had worked my butt off to pay off the mortgage, I probably wouldn’t live debt free for very long. I would refinance the house and get either a readvanceable mortgage or a home equity line of credit.
These mortgage products allow me to pay down the principal outstanding, while simultaneously increase the line of credit available on the house.
It doesn’t matter where your next investment property is, the key is that I would refinance my fully paid off home to take the money out for investment.
We all know that mortgage interest on our own principal residence is not deductible, unless the interest incurred in the money borrowed is used for investment purposes.
The key here is that I will first pay off my home mortgage, refinance it, and take the equity out to invest.
So the mortgage interest on my home is now deductible! This is called the Smith Maneuver.
Being a real estate investor with majority of my portfolio in student rentals, I have a bias toward buying a student rental as my next investment.
Maybe I can even do that in one of the top investment towns, like Hamilton. So I can get the 16% appreciation year over year.
I will be making the top return in the market while making my home mortgage deductible. How cool is that?
The other day Erwin and I were talking about one of the ideas to save money in Tony Robbin’s book “Money: Master the Game”, in which he suggested making a prepayment of the principal portion of your next month’s mortgage payment to reduce the overall interest cost of your home.
Your monthly mortgage payment consists of both mortgage interest and principal. If you choose to prepay the principal portion of the mortgage payment, it is only a fraction of what your monthly mortgage would be.
We both agreed that it’s an interesting idea.
We are going to use this method for our own principal residence with the cash flow generated from the student rentals.
Keep in mind that you have to pay tax on the cash flow from your rental properties anyway. Many investors told me that they just saved any cash flow from their investment properties in a separate bank account, wait for it to grow big enough for the next property’s down payment.
Saving is a good start, but you can make it even more tax efficient.
Like us, use the cash flow generated from your investment properties to make mortgage principal prepayments on your own home. When you have sufficient room in your home equity line of credit for a downpayment, buy another property.
You are saving the mortgage interest cost of your own home in the short run.
You are making your home mortgage interest deductible in the long run.
Remember when you pay down your home mortgage, you are also increasing the room in your line of credit. Once you have accumulated enough room in your line of credit, take it out and invest in your next property. Interest on this loan is tax deductible.
Until next time,
Cherry Chan, CPA, CA
Real Estate Accountant