Last week we looked at the differences between “good” and “bad” debt. Now, let me share with you the three main strategies that counselors use to build wealth out of debt.
Remember that debts should only be considered for the acquisition of appreciative assets such as real estate or securities with a clear and precise plan for disposing of those assets during the life of the asset or through retirement. Many of you may think that it is a good time to think about borrowing to amass wealth, but I must warn you: it will never be risk-free. One should only view debt strategies as part of a well-designed financial plan with a professional. Let’s look at a few options.
Strategy 1 – Using Borrowing to Buy Securities: This is a strategy used by many investors. Remember that investment gains and losses are always compounded when you borrow funds to buy stocks on the stock market. Some counselors will tell you that all you have to do is pay interest on the investment loan. Please dont do this. It is a much better idea to lower your risk by making mixed principal and interest payments. Make sure you have a disciplined investment strategy rather than chasing market trends. Never consider using this method on advisors who believe they can take tactical steps in the marketplace. I’ve seen this in the past and it doesn’t work well for anyone. It is much better to consider investing over a longer period of time to reduce the risks.
Strategy 2 – RRIF flip: This strategy is used to lower the taxation on RRIF withdrawals. Investment loans are set up on unregistered accounts with interest used as a tax deduction to equal the amount deducted from the RRIF each year. The tax is offset by the allowable allowance for interest expense so that taxpayers cannot derive any net tax consequences from their RRIF withdrawals. This approach simply replaces taxes with interest payments on a larger portfolio of assets.
Strategy 3 – Debt Exchange: This strategy is based on the premise of converting your home equity into a deductible debt to buy an investment.
The Canada Revenue Agency can challenge investors under general anti-avoidance rules. Therefore, it is a good idea to seek advice from a good lender and financial planner on this step.
Essentially, you need to remember that you cannot add equity to your personal debt or mortgage. When you have a mortgage on your home and can raise more money, you need to make sure that this new debt is kept separate in order to meet CRA interest tax deduction guidelines.
The best loan product for this strategy is a collateral fee, which is offered by all major banks and most financial institutions. A collateral fee is usually charged in such a way that you get 80 to 100 percent of the value of your primary residence. It can be broken down into several loan segments (usually 10 or more), has no renewal and no term. In my opinion, it is the best product for buying investment property or securities. It can even be used to invest money in a business while adhering to CRA tax guidelines.
Borrowing to invest has long been the habit of many to seek wealth and it can be very lucrative; However, if you overstretch, it can also have its pitfalls. Only you will know what feels right.
Be ruthless in seeking information to initiate your wealth building strategy. Gather a team of people to help you (accountant, lawyer, financial planner). Find other professionals to help you with your personal goals to build a bigger and stronger financial future.