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Not all lines of credit are created equal

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For the smart investor who has run out of available cash to purchase appreciating assets and / or cash flow investments which build up net worth; it is smart to use the equity in their home to free up some cash which can be used to add to net worth and retirement income.

Investors understand that in order to purchase cash flowing rental properties they will need to either come up with the down payment themselves or attempt to find a joint venture partner. The simplest and least expensive source of capital (outside of cash on hand) is home equity. As such, it is common for almost every investor to set up a line of credit (LOC) on their home in addition to their mortgage as a way of converting home equity into increased net worth.

Having said that lines of credits are not created equal; one is a static  LOC while the other is a re-advanceable mortgage LOC combination. Most lenders have been offering the static one for years; ie you need to qualify again to have the LOC. You can apply to access up to 80% loan to value (LTV). Static LOC or HELOC is, quite simply, a line of credit that is placed behind the first mortgage. Which means that if your home increases in value the maximum amount of money that you would be able to draw out would remain the same regardless of how much you had lowered your original mortgage principle amount.

Every time you use your line of credit for an investment purpose, the interest paid is tax deductible. Over time you can literally convert your mortgage into a tax deductible investment. This could develop into a cash cow; having your house provide you passive income. This process is called the Smith Manoeuvre. One thing you have to ensure is that you do not use part of your line of credit for vacationing or personal expenditures without a clear separation as using line of credit for personal use makes the interest from that portion NOT tax deductible and Revenue Canada would stop you from deducting this interest on income.

The difference with the re-advanceable mortgage is that as you pay down your principle on your mortgage, the accessible equity in the line of credit is increased by that same amount. In other words, every dollar of equity that is paid off one’s mortgage is automatically re-advanced to their line of credit. There is no need to re-apply to have it re-advanced as it is done so automatically.

Another advantage is that one only has to pay the interest on the amount of money drawn on the line of credit they access and only when it is accessed instead of paying interest and principle on a mortgage. This is especially beneficial when qualifying for a mortgage.

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About Henri Simoneau

Henri Simoneau

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