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.
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.