Financial Planning

An Alternative to Downsizing


Mark McNulty


June 15, 2013

June 15, 2013

With real estate prices hovering at record highs in Canada, have you ever considered downsizing? If so, here’s the problem – downsize to what? All too often, by the time you pay all costs and buy again into a smaller property and fix it up to be something you love – the amount of money you end up banking is insignificant.

Here is another alternative – borrow against your home to invest. Now before you stop reading, hear me out.

Interest rates are at all-time lows and the consensus is they will not be going up anytime soon. I just checked with a contact at a major bank and we can get a line of credit (with the home as collateral) at three per cent. The loan would be interest only and the interest would be tax-deductible. Therefore, on an after-tax basis the loan against the home would probably cost between 1.5 and 2.0 per cent.

We are not recommending the stocks below, but here is an example of what the big banks are paying via dividends:







This is an average yield of 4.4 per cent, which is more than enough after-tax to pay the interest on your debt. There would still be cash flow left over, and you would also still have the prospect of capital growth in the shares of the banks.

Case Study One: The retired dentistDr. John and his spouse, Mary, are 70 years old. They spend $9,000 per month after-tax including government benefits. They have $1.4 million in RRSPs. They have exhausted their “tax-paid” savings. John and Mary are considering downsizing their home to free up some more cash. It is worth $800,000. The problem, of course, is they are not satisfied with any of the alternatives to where they can downsize.

Therefore, a $400,000 line of credit is set up (to give us room if markets decline). Next, $150,000 is actually borrowed and invested in the banks listed above. This means the interest payments are $4,500 and the dividends earned are $6,450. After tax, this translates into a net profit for John and Mary of $2,434 per year just on the dividends, for a net after-tax yield of 1.6 per cent.

The trading strategy will be to take money off the table any time the shares are up to a certain level. Therefore, if we bought $150,000 and the stocks are now worth $160,000, then $10,000 of shares are sold and these funds are used to pay down the loan.

Case Study Two: The dentist who is mortgage freeAnother dental family we work with live in Toronto, they are both 53 years old, and have a mortgage free home worth $2,000,000. If $500,000 was borrowed using the same numbers as case study one, they would add $8,000 to the tax-paid savings every year. Again, this is just on dividends and assumes no growth in the stock prices of the banks over the next decade.

The reason we consider this as an option is because they have very little savings built up personally. They have a portfolio of $2.4 million but it is all in corporations and RRSPs. For future tax planning, it will be good to build up tax-paid money in order to allow us to draw on the tax-deferred money at a slower pace, thereby lowering their tax bill in the future.

The DownsideOf course, we all know borrowing to invest increases our exposure to the ups and downs of the stock market. Therefore, if you ever consider this as an option it is important to first understand the difference between risk and volatility. Risk is the possibility that you might lose the money you invest. For example, if you speculated on Nortel and didn’t sell, your money is gone. Another risk is if you sold out after the 2008 stock market crash, you missed out on making all the money back.

Volatility, on the other hand, just means the ups and downs your investments undergo. Not many Canadians or investment professionals believe that if you buy the big banks, you risk losing all your money. The prices of the stocks go up and down, but that is volatility – not risk.

For these two families, we have ample assets outside of this strategy and the improved cash flow is worth the volatility they will encounter. However, this plan is not for everyone and must be considered carefully before implementing. PA