Real Estate

Heloc to refinance mortgage? Cash damming strategy?

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  • May 31st, 2017 10:41 am
Deal Addict
Sep 14, 2007
1001 posts
386 upvotes
Toronto

Heloc to refinance mortgage? Cash damming strategy?

Here's the scenario, I purchased a home which will be my primary residence. My wife has a condo which we plan to keep and rent out. She's on a 5 year fixed at 2.95%. Her banker suggested to take out a Heloc ($200k) on her condo at 2% variable. The remaining mortgage on her condo is 200k. She would be able to pay off the mortgage using the Heloc and basically exchanged 2.95% fixed with a 2% variable. Does this make sense or is there something else I'm not factoring in? I know Heloc rates can change instantly without warning which is inherently riskier, but with a 0.95% difference, it seems like a no brainer.

Then it got me thinking, why doesn't everyone just refinance mortgages with Helocs if Helocs are at lower rates than mortgages in the first place? Is it because normally the spread is much smaller? ie. If today's 5 year variable on a mortgage is 2.15%, taking out a Heloc at 2% isn't a huge difference but there's more risk?

Second part of the question is understanding how to implement the cash damming strategy. So my understanding is that, mortgage interest and interest expenses on your rental property are tax deductible. So the idea is use the rental income to pay down the mortgage of our principal property. Meanwhile the 2% Heloc will be a tax deductible expense (or if you guys explain the fallacy of my logic above, then the 2.95% mortgage interest becomes the tax deductible expense). So 2% on 200k residual principal is 4k, which is deducted from my wife's annual salary + annual rental income to decrease the reported annual income.

This excerpt was taken from a website explaining the strategy:
"Once you’ve decided the strategy is for you, the next step is to setup your primary residence mortgage so that you can re-advance principal after it has been paid down. This is typically referred to as a HELOC structure – investors should be cautioned that not all HELOC products are created equal and some can cause administrative headaches when implementing this strategy. The final step is to calculate the precise amounts that will be cash dammed and “approve” the monthly cash flow cycle. At this point, you are ready to begin executing transactions to convert your principal residence mortgage into a tax deductible investment loan. Investors are reminded that they should seek tax advice from a chartered accountant prior to executing this strategy."

What does it mean to setup my primary residence mortgage so I can re-advance principal after it has been paid down? How do HELOC structures differ, what do I need to look out for? How does the monthly cash flow cycle get "approved"? Is it plotting out the numbers to understand the cash flows for the primary residence and the rental property?

ie.
Primary Residence:
Monthly mortgage payments @ 2.19% 5 year variable
Broken down into payments from my salary, wife's salary, rental income from condo

Rental Property:
Monthly mortgage (turned Heloc) payments @ 2% (refinanced with Heloc)
Interest expense tax deductible


Third and last main question is trying to understand the concept of borrowing for investing.
So if anybody can go take out a Heloc today at 2% rates from their property, and take that money and go invest in a standard portfolio and aim for what 5-6% returns a year, why don't they?
Is it because when you sell these investments you realize capital gains tax and that decreases that 5-6% returns at whatever your tax bracket is. Is it because that 2% Heloc could go up and that 5-6% return is not even guaranteed in a bad year which could end up putting you at a loss since you still need to pay off that Heloc, and your creditors aren't going to wait for your portfolio to go back up to pay them back so there's essentially too much risk being taken on to gain too little return?
Similarly, why doesn't anybody that has a mortgage today simply take out a Heloc and pay down the mortgage to convert whatever mortgage rate to a lower Heloc rate? There's clearly something I don't understand about Heloc. I know Heloc is intended to be for short term use like renovations etc. while mortgage is intended as a long term loan, but that can't be the only difference. What am I missing here?
Sorry for all the stupid questions, just trying to educate myself here.
10 replies
Sr. Member
Dec 19, 2010
907 posts
348 upvotes
Toronto, Ontario
i'm no expert but my 2 cents on this is first of all you need the equity in your home to borrow money from your HELOC.
i believe most banks only allow 65% LTV and some go as high as 70-80% LTV.

so if you buy a house for $600,000 let's say and you put down 20%, now you have a $480,000 mortgage.
by your thinking, if you try to get a HELOC and say your house is appraised slightly higher at $700,000. let's say you dont use a big bank but an alternative lender and they allow 70% LTV that would give you the power to borrow $490,000 (70% of $700,000).
but the fact that you are already borrowing $480,000... that means you can only borrow $10,000 on your HELOC.

unless you bought your house before the crazy increase in the last few years and have alot of equity in the home, this does not work.

and for those that do have alot of equity and their appraised value has jumped up 200%, this may work? but someone else can probably better elaborate.
Member
Apr 27, 2014
390 posts
135 upvotes
Mississauga, ON
Most HELOCs are at prime + 0.5 right now or in other words a current rate of 3.2%. Please give details of this offer of prime -0.7 if it is real.
Sr. Member
Dec 24, 2007
858 posts
144 upvotes
GTA
sounds fishy when I see HELOC is at prime - 0.7 ?? usually mortgage is lower than HELOC...
Deal Guru
User avatar
Feb 2, 2014
11233 posts
3350 upvotes
Toronto
stryder1587 wrote: Here's the scenario, I purchased a home which will be my primary residence. My wife has a condo which we plan to keep and rent out. She's on a 5 year fixed at 2.95%. Her banker suggested to take out a Heloc ($200k) on her condo at 2% variable. The remaining mortgage on her condo is 200k. She would be able to pay off the mortgage using the Heloc and basically exchanged 2.95% fixed with a 2% variable. Does this make sense or is there something else I'm not factoring in? I know Heloc rates can change instantly without warning which is inherently riskier, but with a 0.95% difference, it seems like a no brainer.

Then it got me thinking, why doesn't everyone just refinance mortgages with Helocs if Helocs are at lower rates than mortgages in the first place? Is it because normally the spread is much smaller? ie. If today's 5 year variable on a mortgage is 2.15%, taking out a Heloc at 2% isn't a huge difference but there's more risk?

Second part of the question is understanding how to implement the cash damming strategy. So my understanding is that, mortgage interest and interest expenses on your rental property are tax deductible. So the idea is use the rental income to pay down the mortgage of our principal property. Meanwhile the 2% Heloc will be a tax deductible expense (or if you guys explain the fallacy of my logic above, then the 2.95% mortgage interest becomes the tax deductible expense). So 2% on 200k residual principal is 4k, which is deducted from my wife's annual salary + annual rental income to decrease the reported annual income.

This excerpt was taken from a website explaining the strategy:
"Once you’ve decided the strategy is for you, the next step is to setup your primary residence mortgage so that you can re-advance principal after it has been paid down. This is typically referred to as a HELOC structure – investors should be cautioned that not all HELOC products are created equal and some can cause administrative headaches when implementing this strategy. The final step is to calculate the precise amounts that will be cash dammed and “approve” the monthly cash flow cycle. At this point, you are ready to begin executing transactions to convert your principal residence mortgage into a tax deductible investment loan. Investors are reminded that they should seek tax advice from a chartered accountant prior to executing this strategy."

What does it mean to setup my primary residence mortgage so I can re-advance principal after it has been paid down? How do HELOC structures differ, what do I need to look out for? How does the monthly cash flow cycle get "approved"? Is it plotting out the numbers to understand the cash flows for the primary residence and the rental property?

ie.
Primary Residence:
Monthly mortgage payments @ 2.19% 5 year variable
Broken down into payments from my salary, wife's salary, rental income from condo

Rental Property:
Monthly mortgage (turned Heloc) payments @ 2% (refinanced with Heloc)
Interest expense tax deductible


Third and last main question is trying to understand the concept of borrowing for investing.
So if anybody can go take out a Heloc today at 2% rates from their property, and take that money and go invest in a standard portfolio and aim for what 5-6% returns a year, why don't they?
Is it because when you sell these investments you realize capital gains tax and that decreases that 5-6% returns at whatever your tax bracket is. Is it because that 2% Heloc could go up and that 5-6% return is not even guaranteed in a bad year which could end up putting you at a loss since you still need to pay off that Heloc, and your creditors aren't going to wait for your portfolio to go back up to pay them back so there's essentially too much risk being taken on to gain too little return?
Similarly, why doesn't anybody that has a mortgage today simply take out a Heloc and pay down the mortgage to convert whatever mortgage rate to a lower Heloc rate? There's clearly something I don't understand about Heloc. I know Heloc is intended to be for short term use like renovations etc. while mortgage is intended as a long term loan, but that can't be the only difference. What am I missing here?
Sorry for all the stupid questions, just trying to educate myself here.
You have a few big misunderstandings....

1-HELOC rate is NOT Prime -.70%. That's a variable mortgage rate. It sounds like the bank rep is trying to sell you an all-in-one product. The mortgage portion of the all-in-one product is Prime -.70% and the HELOC portion is likely Prime +0% to Prime +.50%. Best mortgage rate is Prime -.95% on my end, so you're not getting anything spectacular from your bank. Also, if you take the all-in-one product, your mortgage becomes a collateral charge and you can't switch it over for free ever (avoid collateral charge mortgages).

2-If the proceeds of the refinance are being used to purchase an owner-occupied property, then you CANNOT deduct the interest when you file. The proceeds have to be used for investment purchases, which they are clearly not. If you used the proceeds to buy another rental property, then the interest is tax deductible.

3-5-6% return? Yes, you can get returns of 5-6% from the market, but the investment will not be risk-free (risk free returns are much, much lower). So you're essentially borrowing at 2% variable and "gambling" the money. I am NOT saying that it's a bad idea, just be clear that you are taking risk if you expect returns at 5-6% and that is the reason for the difference. A secured mortgage from a AAA borrower is much less risky then investments that will give you 5-6% returns....that is the reason for the difference.
Kevin Somnauth, CFA
Principal Broker/Owner - First Toronto Mortgage - MA (Ontario #13176, BC #X301007)
Real Estate Salesperson - Century 21 Innovative
Deal Addict
Sep 14, 2007
1001 posts
386 upvotes
Toronto
She has equity built up as she bought her condo 3 years ago and prices have gone up. I told her how nobody believed there's a HELOC rate of Prime -0.7
I'm asking her to get details from TD for whatever it is they're trying to sell her. Assuming it's true and she can take out 200k at 2.0 something %.
She would give me 70k for down payment. Prepay 10% midterm without penalty on her condo which would be 10% x 200k = 20k, then invest the rest of the 110k.
The 70k for my down payment would be borrowing at 2% instead of selling her investments (which should make more than 2%)
The 20k would be for reducing her mortgage which is at 2.95% and borrowing at 2% to do.
The 110k for investing would be borrowing at 2% to make more on investments.

Is this too risky? Should she just sell her investments for the 70k, not prepay her mortgage and not borrow more to invest?
Member
Jul 16, 2006
414 posts
211 upvotes
I currently am doing that right now. Paying down my 2.94% mortgage with Helocs at better rates,

Where the heck did you get a 2% variable, that is an amazing rate. I am with TD and was never offered 2%
Newbie
Apr 3, 2017
40 posts
3 upvotes
The best I've seen from one of the big banks was a CIBC promotion for HELOCS at 2.25% - it was only for the first 3 months of use though.


rich24 wrote: I currently am doing that right now. Paying down my 2.94% mortgage with Helocs at better rates,

Where the heck did you get a 2% variable, that is an amazing rate. I am with TD and was never offered 2%
Jr. Member
Dec 14, 2016
193 posts
176 upvotes
Toronto
I have also encountered this... there is a low ~2.2% heloc rate at TD that has to be on a locked term of 5 years I believe but with a variable rate. So it behaves like a variable mortgage rate... at least this is my understanding of it I don't remember the details as it was a few months ago. However you would not have the flexibility to fill the borrowed amount back up as you would when the heloc remains open.
Sr. Member
Jan 3, 2013
919 posts
475 upvotes
Mississauga
There are HELOCs available for 2%. I got a HELOC last December from CIBC at prime -.70% until July 1. In July it goes to prime +.50%.
Deal Addict
Sep 14, 2007
1001 posts
386 upvotes
Toronto
Ok, here's what I've heard. Basically TD is willing to be the 2nd charge, with her mortgage lender being the 1st charge. They are lending based on her property being collateral, so it's somewhat like a Heloc, but structured like a mortgage and rates like a mortgage. There's an option of 2.0 something % var or 2.39% 5 year fixed. Basically it's like an extension on your mortgage amount at current market rates for var or fixed based on the fact that some equity has been built up due to price appreciation and principal paydown, as well as having money in the bank. Payment schedules would be biweekly/monthly just like a mortgage too. It's kind of like a mortgage on top of your existing mortgage but she would have the advantage of borrowing at better rates than her original mortgage.

The risk is in over leveraging and hoping to beat the var rate with investments. Also making sure there's sufficient cash flow to pay down her existing mortgage and her extended mortgage.
Would you guys take this extended mortgage at current var rates (2.0_%) to invest and paydown first mortgage?

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