The day one becomes free of their mortgage is a big day and many celebrate by having a party and burning the mortgage papers. Yet most do not know that a mortgage can make you a lot of money if you know how to properly use them. Let me show you a little investment trick that can do just that.
If you have a free and clear home, congratulation! It’s time to get back into mega debt! You see, having the bulk of your net worth tied up in a single asset - your house - is a dangerous, unstable and dumb situation to be in. I know, this is going against everything your parents ever taught you. Well, if you want to end up like your parents, then do what they tell you.
The Home Equity Line Of Credit
Go to your bank and arrange a home equity line of credit, with interest only monthly payments. A home equity line of credit is basically a very big credit line secured by a mortgage on your house. A bank will extend a credit limit up to 75% of the value of your home. It’s just like a credit card. You should be able to get interest rate on the credit line at prime (currently 6%), and is charged to only the portion you use and you can repay it back at any time. However, you’re never going to want to pay this off.
Let’s say you get a home equity line of credit for $300,000 (75% of a $400,000 house). Take the money out and put into low fee equity based index funds (you can use mutual funds if you like but I hate them). You will be making interest only payments on the line of credits. Because the money is being used to buy investments, the interest is tax deductible. Still you will need to come up with the $1,500 interest payments each month. How do you do that?
The Systematic Withdrawal Plan
Have your financial planner set up a systematic withdrawal plan (SWP) from your index fund to cover the monthly interest payments on the home equity line of credit. Now the fund is actually making the loan payments, rather than you. But every year when you fill out your tax return, you’ll be able to deduct the $18,000 of interest off your taxes! That will trigger a $9,000 tax refund if you’re in the top tax bracket.
Despite the fact you have removed money through the systematic withdrawal plan to cover all interest charges, the index fund should give you substantial capital growth. It doesn’t even have to grow 6% per year in order for you to be ahead because of the deductible interest. This is a win-win situation: you’re leveraging your house with a fully deductible mortgage and you’re using a systematic withdrawal plan so no money comes out of your pocket for financing.
What if you borrow against your home, and buy index funds that decline in value? Don’t worry about it. Unless history is no guide, equity investments increase in value over the long haul. Of course, there are years when markets decline, but they are far outnumbered by years of gains. As long as your investment performs at a rate that exceeds your withdrawal rate, your investment will continue to grow. This is not a short term investment. You will be holding it for a long time (min 5 years), the longer the better. As a matter of fact you may want to increase the size of the line of credit as the value on your house goes up so you can buy more and get an even bigger tax deduction!
The above strategy can be done even if you don’t have a free and clear house. Banks will lend up to 75% on a home equity line of credit. So if you already have 50% equity in your house you can get a home equity line for the remaining 25% and increase it as your home mortgage gets paid down (Smith Manoeuvre).
This is how you built real wealth. Creating wealth by saving your pennies is a really slow and painful way to do it. If you want to get rich, you have to use a lot of leverage and get heavy into debt. Just make sure it’s good debt!