Last week we looked at the differences of “Good” debt versus “Bad” debt. Now I want to provide you with the three main strategies used by advisors to build wealth from debt.
Remember, debt should only be considered for the acquisition of appreciating assets such as real estate or securities with a clear and concise plan to eliminate it during the life of the asset or by retirement. Many of you may think it is a great time to consider borrowing for the purpose of accumulating wealth, however I must caution you; it will never be without risks. One should only consider debt strategies as part of a well thought out financial plan with a professional. Let’s look at some options.
Strategy One: leverage lending to purchase securities. This is a strategy done by many investors. Remember, investment gains and losses are always amplified when you borrow funds to purchase securities in the stock market. Some advisors will tell you that you only need to pay interest only on the investment loan. Please do not do this. It is a much better idea to lower the risk by making blended principal and interest payments. Make sure you follow a disciplined investment strategy rather than chasing market trends. Never consider doing this method with an advisor who thinks they can make tactical moves on the market. I have seen this in the past, and it never works out good for anyone. It is a much better idea to consider the investment over a longer time horizon to reduce risks.
Strategy Two: RRIF flip. This strategy is used to reduce the taxation on RRIF withdrawals. Investment loans are setup in non-registered accounts with the interest being used as a tax deduction to match the amount withdrawn from ones RRIF each year. The tax is balanced by the deduction allowed for the interest expense, effectively allowing taxpayers to experience no net tax consequences from their RRIF withdrawals. In this method, taxes are simply being replaced by interest payments on a larger portfolio of assets.
Strategy Three: debt flip. This strategy is based on the premise of changing your home equity into a deductible debt to purchase an investment. The CRA (Canada Revenue Agency) may be challenging investors under general anti-avoidance rules, so it is a good idea to seek the guidance of a good lender and a financial planner when considering this move. Essentially, you must remember that you cannot amalgamate any equity-take-outs into your personal debt or mortgage. If you have a mortgage on your home and have room to borrow more, you must ensure that this new debt is kept separated in order to meet the CRA guidelines for interest tax deductions.
The best lending product to choose for this strategy is a collateral charge offered by all the big banks and most financial institutions. A collateral charge is usually setup to give you 80 to 100 per cent of the value of your primary residence, can be split into multiple loan segments (usually 10 or more), has no renewal and no term. In my opinion, it is the best product to use for the purchase of investment properties or securities. It can even be used to inject money into a business while still conforming to the CRA tax guidelines.
Borrowing to invest has long been a habit by many to try and build wealth, and it can be very lucrative; however, it can also have its pitfalls when you overextend to take on too much debt for the wrong reasons. Only you will know what feels right. Be ruthless when seeking information to initiate your strategy to build wealth. Create a team of people to help you, (accountant, lawyer, financial planner). Never do this alone. You can’t know everything. Find other professionals that will assist you with your personal goals to build a bigger and stronger financial future.
Good luck and best wishes
Written by Christine Ibbotson, author of three finance books and the Canadian best-selling book, “How to Retire Debt Free & Wealthy”. Go to www.askthemoneylady.ca or send a question to firstname.lastname@example.org .