Of course, for most of us, life is not like that. Occasionally, we have to borrow money. We borrow it to buy our cars and pay for our vacations – and we borrow it to buy our homes. When we do, we pay for it dearly. Even at today’s bargain-basement mortgage rates, a $200,000 home costs more than $400,000 over the 25-year term of a mortgage. Toss in the fact that most middle-income earners are paying half of what they earn to the government in the form of taxes, and our struggling homebuyer is forced to earn in excess of $800,000 in order to pay off his or her $200,000 loan.
But what can you do? That’s the way the world works, so most of us knuckle down, make our payments and dream about the day we actually “own” our home. At the end of the process, we find ourselves house-rich, cash-poor and desperately behind in our retirement savings plans.
Is there another way? Fraser Smith, a retired financial adviser living in Saanichton, B.C., and author of a little book entitled The Smith Manoeuvre, says there is. All you have to do is make your mortgage tax-deductible. This will do two things:
- free up capital you can use to pay down your mortgage faster, and
- allow you to supercharge your retirement savings program. Here’s how it works.
In Canada, banks will typically lend you 75% of the value of your home. If you own a free and clear home worth $100,000, the bank may lend you $75,000 to invest in something else. If you have a mortgage outstanding, it will be 75% less whatever you owe. For example, if you still owe $75,000 on the mortgage, then you’re at break even. However, if you only owe $74,000, there’s $1,000 sitting in your home you could borrow to invest.
And, according to Smith, that’s precisely what you should be doing. Borrowing it and using it to buy interest-bearing investments for your retirement. But wait a minute, you say, isn’t that just robbing Peter to pay Paul? No, and here’s why.
In Canada, when you borrow money to invest, the interest on the loan is tax-deductible, a bonus that gets you a tax refund cheque if you’re employed or reduces your taxes if you’re self-employed. You then take that refund or excess income and plunk it down on your mortgage.
This has the virtue of increasing the equity in your home, equity you can then capitalize on by borrowing on it and using the money to buy more investments. Once again, the interest is tax-deductible, generating an even bigger refund cheque next year or reducing your taxes even further, allowing you to pay off your mortgage that much faster. And so it goes.
At worst, this plan reduces the time it takes to pay off your mortgage by about 2.5 years, while at the same time getting you started on the road to retirement savings.