numbers
Say you're interested in buying a house or condo that's 400k. Assuming you have more than 400k in your bank account, and can pay off the house or condo in full without taking out a mortgage, is it worth it to save on the interest payments you'd be making if you took out a mortgage and pay for the property in full? Or would you be better off taking out a mortgage and leaving that money for investment where you can potentially make gains above and beyond the interest you'd be paying for your mortgage?
I know that it all depends on the returns that are expected to be made on my investments, but if someone is good at crunching out the numbers based on average returns in the current market (stocks, bonds, GIC's, savings acccounts etc.) vs. current interest on a mortgage, I'd love to see the numbers. Of course everything is highly variable in the scenario I've given, but your thoughts would be appreciated.
Assuming you borrow $300K [can get up to 80% normally but this leaves you a cushion and $300K is a nice round number] you have to then make an assumption about your expected long term interest rate and your tax bracket. Looking out 10 or 20 years you might start with a 5% long term borrowing cost [much lower right now but who knows when renewing and if you will go variable or fixed then]. If you assume a 40% tax bracket then your after tax cost of borrowing is 3.0%.
You then have to make an assumption about your long term growth rate. You could use 6%, 8% and 10% for starters if you will be using mostly equities for long term growth [which is presumably your main objective].
principle...... interest rate..... 10 years [net]...... 20 years [net]
$300K....... 6% growth.......... $537K [$190K]......... $962K [$530K]
............... 8% growth......... $648K [$278K]......... $1.4M [$879K]
............... 10% growth......... $778K [$382K]......... $2.0M [$1.37M]
The net values shown in brackets are after paying off the $300K loan and then paying capital gains tax of 20% [i.e. half your assumed 40% tax rate].
You would have to pay the 3% after tax interest cost each year [i.e. $9K or $750 monthly] to carry the leveraged loan but this lets the $300K investment compound.
This scenario doesn't account for tax on distributions from the investments but there are mutual fund vehicles that eliminate or minimize distributions and convert them all to capital gains [even from interest payments] when the investments are eventually sold.
The large net amounts you might expect to gain will advance your long term plans significantly. One way to get a sense of this is to think how much net you would like from your investments to augment your retirement cash flow. You can take this number [$30K, $50K, etc.] and divide it into the net after tax gain you would have from leveraging and this might approximate how many years earlier you can retire.
To compare apples to apples you could consider what you would do with the $9K per year carrying cost that would be available if you didn't leverage. Investing the $9000 per year carrying cost would grow to $130K over ten years at 8% growth and
this would net out to $122K after capital gain taxes [compared to $278K net above under the same assumptions if you leveraged]. Over the twenty years, investing the $9000 per annum would net $365K after taxes vs. a net of $879K by leveraging.
Hope that provides some insight and let me know if you have any questions or comments.
D.
