Is Borrowing To Invest Worth It
Borrowing to invest can enable an investor to amplify their returns by leveraging their capital invested. But is borrowing worthwhile?
You can come up with different results to support or oppose borrowing to invest, depending upon the time period you pick. But if we go way back to 1935, the long-term average prime lending rate in Canada has been about 6.6%. Canadian stocks as represented by the TSX have returned 9.5% per year. The S& P 500 in the U.S. has generated about an 11% annualized return including reinvested dividends.
At first glance, borrowing to invest in stocks seems to make sense. But most investors would not invest 100% into stocks. Adding in bonds and other fixed-income would reduce returns. Deducting investment fees and transaction costs would reduce returns. Introducing potential bad investor or advisor behaviour, like buying high or selling low, could also limit the net benefit.
Real estate is a much more difficult asset class for which to identify historical returns. This is in large part because the return is based not just on price appreciation, but also net rental income. Rents are not tracked the same way historical dividends are for stocks.
Real estate is also less volatile. Stocks fall roughly three years out of every 10 years, whereas real estate generally appreciates in value. As such, it is a more stable asset class.
Remortgaging If You Are Moving House
Moving to a new house without selling your existing property is certainly possible. There are lenders that offer let to buy mortgages, which enable borrowers to let their existing property to tenants and raise the funds to buy, or put down a deposit on, a new home. If you have a good rate on your current mortgage, you could also look at porting your mortgage to the new property.
If this is something that interests you, get in touch to speak to a specialist let to buy mortgage advisor.
Should You Borrow To Invest In An Rrsp
When borrowing to invest, its all about ensuring that the returns outweigh the cost to borrow. And investing in tax havens is a great way to make the most of borrowed funds when investing.
Another smart way to borrow to invest is by taking out an RRSP loan. This involves using all of your allowable RRSP contribution room and deducting it from your taxable income within the same year that you make your contributions.
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It Depends On How You Invest It
I know plenty of people who have borrowed against their own homes to buy an investment property. Flippers do this all the time for short-term investments.
Entrepreneurs often take second loans on their homes to start businesses.
Borrowing to buy stocks through a margin account is common. So inevitably, some individual investors take out a home equity loan to invest in stocks at times.
Sounds like a ticket for bankruptcy if done carelessly, but what about for conservative dividend growth investors?
Or what about using a home equity loan to pay for education? Is that a harmful or risky investment? It depends on the degree and student, but the return on investment from education is one of the highest over the long-term.
Taking big risks means big rewards. Its all about how much risk youre willing to take to accomplish your goals.
Borrowing money from one property to buy an investment property, is broadly acceptable.
Take the classic real estate investing example, using two different investor approaches. Investor #1 has $100,000 and pays cash for a rental property of the same value. Hell make good cash flow on the property since he isnt paying a mortgage, and over time the property will appreciate.
This is a safe investment that would cash flow nicely. Assuming a 3% appreciation rate on the property, it would be worth $243,000 in 30 years.
There are also significant tax benefits to real estate investing.
Lastly, my Rich Dad Poor Dad hat
Getting A Remortgage To Buy A Second Home
You may be thinking of taking out a second mortgage but rather than doing this, you could remortgage to buy a second home.
You can opt for a remortgage if you own your current home outright or have built up some equity.
Dont be worried about calculating the equity of your property as its quite simple:
If you own your current property outright, then the equity of it is the full value of your property.
If you have a mortgage on it, then you can get the equity for it by subtracting your remaining mortgage debt from the propertys full value.
Looking for a lender to provide you with a remortgage shouldnt be too difficult as these specialised lenders are quite common.
When opting for a remortgage to buy another home, its highly important that you look at the secured loan offer thoroughly and go through all the information the lender has offered to you.Merely looking at the headline rate is not enough and you should definitely take other costs and fees into account such as arrangement fees, valuation costs, legal fees as well as any other costs which may be incurred throughout the process.
If there is still a mortgage in place on your current property and youre taking out a remortgage to buy another one, then there may be early repayment/redemption fees which you need to keep in mind.
Seeking mortgage advice from a professional when considering a remortgage to buy another property can come in handy because they could turn you onto lenders with lower rates.
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Leveraging Home Equity Line Of Credit To Invest
Using funds from a home equity line of credit to invest in dividend stocks would be similar to the scenario above, but with a few major differences.
- Youd likely have access to a significantly larger sum of money since the funds are secured by the equity in your home. Of course, that also increases your risk since your home could be at stake if youre unable to make the interest payments.
- If you arent disciplined about paying back the money you withdraw from your HELOC, you could end up paying more in total interest over time, even if your rate is low.
- Borrowing and investing a larger sum of money might make it psychologically harder for you to stay invested if theres a market downturn. For example, a 20% annual market loss on a $10,000 investment is $2,000, but the same percentage loss on a $100,000 investment is $20,000. And that loss may feel even more acute when you add the fact that your investment may be worth less than the outstanding debt on your HELOC.
To recap, leveraging your HELOC to invest could be a smart strategy if you:
- Have a lot to gain through the interest tax deductions
- Are certain youll be able to make your interest payments with ease and have a plan to pay back the principal
- Plan to invest for at least 10 years and will stay in the market even if you experience sizable annual losses.
READ MORE: Refinance Mortgage vs. Home Equity Loan vs. HELOC
Advantages Of Borrowing To Invest In Stocks And Etfs
Stocks and exchange-traded funds are common investment assets among Canadians. If you dont have the money readily available to invest, borrowing might be an option. Here are some benefits to consider when it comes to borrowing to invest in stocks and ETFs:
- Deductible Interest Expense You can effectively reduce your regular income when you file your taxes by deducting your interest expenses from your investment. In turn, this will lower what you owe in taxes and potentially save you a lot of money.
- Lower Tax Rates On Dividends From Canadian Companies If you regularly collect dividends from investments made in Canadian stocks, the tax rate your dividends are taxed at will be lower than other investments.
- Dividend Tax Credit On Gains Dividends from non-registered account investments must be declared as income when you file your taxes, but you can claim a dividend tax credit. Since only 50% of capital gains are taxable, this can help reduce your tax obligations.
- Stock Investments Are Easy To Sell Since investments in stocks are liquid, selling them is much faster and easier compared to other investment types where your money is locked in or much more difficult to convert into cash.
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How Much Home Equity Do You Have
Your home equity value is the difference between the current market value of your home and the total sum of debts registered against it.
The credit available to you as a borrower through a home equity loan depends on how much equity you have. Suppose that your home is worth $250,000 and you owe $150,000 on your mortgage. Simply subtract your remaining mortgage from the home’s value, and you’ll come up with $100,000 in home equity.
To Pay Off Car Loans Or Credit Cards
A cash-out refinance can be a good idea if your home has gone up in value. It is often the best option if you need cash right away and you also qualify to get a better interest rate than on your first mortgage.
If your credit score is much higher than when you purchased your home, then a lower rate can help offset the higher payment that will come with a larger balance that includes the cash-out amount. If you use the cash-out amount to pay off other debts, such as car loans or credit cards, then your overall cash flow may improve. Your credit score may even rise enough to warrant another refinance in the future.
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What Are Some Reasons For Borrowing Money Against Your House To Buy Another Property
There can be several reasons and circumstances due to which you could be looking to borrow money against your current property to buy another one.Some reasons are:
- You want your current home to be an investment property on a buy-to-let basis.
- You may be wanting to raise money in order to purchase a holiday-let property. This would be different from a buy-to-let property but would still be an investment as you would gain revenue from people using it as a holiday rental property.
- You may be wanting a 2nd home in a fancy location such as by the sea. In order to fund this home, you may be opting for a remortgage or a mortgage on your current property.
- You could remortgage your existing property for a Let-to-Buy purpose. For this, you would rent out your current home to purchase another property for yourself where you would live.
- You may want to remortgage your current residential property so you can purchase a friend or a family member a home for them to live in.
Can You Remortgage To Buy Another House
Yes. This is possible as long as you qualify for a remortgage and refinancing your property would raise the amount needed to fund the purchase of your new house. You will also need to convince your mortgage lender that you can afford to pay your refinanced mortgage in addition to the debt secured against the new property.
Assuming eligibility isnt an issue, there are many different scenarios where you can remortgage to buy a second property, such as
- Let to buy
- To invest in buy to let
- Buy a holiday let
- Buy a holiday / second home
- Remortgage to invest in commercial property
- Remortgage of a commercial property
Read on to find out more about each type of agreement and how to secure the best deal for your needs and circumstances.
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Pros And Cons Of Using A Home Equity Loan To Buy Another House
The major advantage of using a home equity loan to buy a second home is that it may be your best significant source of funding if you find yourself house-rich but cash-poor. Another potential plus is that interest rates on home equity loans will often be lower than other forms of borrowing, though they are typically higher than interest rates on a mortgage.
The biggest downside of using a home equity loan for buying another propertyor for any other purposeis that you are putting your primary residence at risk because it serves as collateral to secure the loan. If you find yourself unable to make the payments on your home equity loan, the lender could foreclose on your home and evict you.
An additional danger is that by taking on a home equity loan, especially if you still owe money on your first mortgage, you could find yourself overwhelmed by debt if you face an unexpected financial reversal, such as a job loss or big medical bills. Indeed, you could wind up obligated to pay off three mortgages at once: the remainder of the mortgage on your primary residence, a mortgage on your second house , and your home equity loan.
Finally, another downside is that youll have to pay closing costs on the home equity loan, which could be between 2% and 5% of the total loan cost. Youll also have to pay closing costs on the home that youre buying.
Why Use Home Equity
Tapping your home equity can be a convenient, low-cost way to borrow large sums at favorable interest rates to pay for home repairs or debt consolidation.
However, the right type of loan depends on your needs and what you plan to use the money for.
If youre looking to spend as you go and only pay for what youve borrowed, when youve borrowed it, a HELOC is probably a better option, says Sean Murphy, assistant vice president of equity lending at Navy Federal Credit Union. But if you are looking for a fixed monthly payment and a large sum of cash up front, a home equity loan is probably the better option.
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How Do I Go About Remortgaging To Buy Another Property
The first step is to speak to us and get the best advice. This is something we help many customers with on a regular basis and will know the best route for you to go down depending on your individual circumstances and requirements.
We have access to over 90 lenders and each lenders criteria can differ significantly so we want to ensure we place you with the right lender for you in order for you to be successful in remortgaging to buy another property. For whatever your reason is.
Use Your Equity To Renovate Your Current Home
Of course, you may want to use the equity you have in your current property to make some improvements.
A lot of people withdraw equity for renovation, says van der Westhuyzen. Some people may want to add value to their property, or some may need to renovate because of a change in life circumstances.
For example, they might want to add a bedroom to the property because they’re about to start a family or they have a child and want to have a second, and so on. So they’re changing the property to suit their current life stage.
Some people withdraw equity to renovate because of a change in life circumstances.
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The Value Of Your Home Can Decline
Keep in mind that theres no guarantee that your home value will increase substantially over time. Your home may even lose value in times of economic downturn or suffer damage from fire or extreme weather.
If you take out a home equity loan or HELOC and the value of your home declines, you could end up owing more between the loan and your mortgage than what your home is worth. This situation is sometimes referred to as being underwater on your mortgage.
Say, for example, that you owe $300,000 on your mortgage but the home prices in your area tanked, and now the market value of your home is just $200,000. Your mortgage would be $100,000 more than the value of your home. If your mortgage is underwater, its much harder to get approved for debt refinancing or a new loan with more favorable conditions.
If You Have Poor Credit
Home equity loans can be easier to qualify for if you have bad credit, because lenders have a way to manage their risk when your home is securing the loan. Nevertheless, approval is not guaranteed.
Collateral helps, but lendershave to be careful not to lend too much, or they can risk significant losses. It was extremely easy to get approved for first and second mortgages before 2007, but things changed after the housing crisis. Lenders are now evaluating loan applications more carefully.
All mortgage loans typically require extensive documentation, and home equity loans are only approved if you can demonstrate an ability to repay. Lenders are required by law to verify your finances, and you’ll have to provide proof of income, access to tax records, and more. The same legal requirement doesn’t exist for HELOCs, but you’re still very likely to be asked for the same kind of information.
Your credit score directly affects the interest rate you’ll pay. The lower your score, the higher your interest rate is likely to be.
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What Is Usable Equity
When talking about equity, its important to note that there are two terms often referenced: equity and useable equity. Useable equity comes into play when youre looking to use your equity to apply for another loan.
Useable equity is up to 80% of your propertys current value minus what is still owing on the mortgage. For context, lets say your property is valued at $500,000 and you have $150,000 left on your mortgage. This is how the work useable equity would be calculated:
$400,000 $150,000 = $250,000 in useable equity
To get an estimate of the amount of equity you may have available in your property, you can use an online tool, like Westpacs Home Equity Calculator.