The fact that you are reading this should tell you that you’re looking for a better way to structure your financial affairs. Or at the very least, that you understand that you have more options for your mortgage. Setting up your mortgage on your primary residence for tax efficiency is not a new concept. High end financial advisers and chartered accountants have been recommending this type of financial strategy to their wealthy clients for decades.
The top 3 reasons for setting up your residence for tax efficiency:
- Paying less tax
- Reducing debt by paying off your mortgage faster
- Accelerating wealth by reinvesting the benefits
The Challenge
The rules are complex. Getting the right level of advice and support to properly implement the plan is tough. Not every investor has the time or resources to address all aspects of such an undertaking. To make things even more challenging, Canadians approach their financial affairs separately; obtaining mortgage advice from one adviser and investment advice from another.
There is however, a solution that is designed for homeowners looking to take advantage of an advanced mortgage strategy holistically, without trying to figure things out all on their own.
A Tax Deductible Mortgage Plan
Principal interest on one’s primary residence mortgage is not automatically tax-deductible. There is, however, a systematic approach that will allow one to convert non-deductible mortgage debt into a tax-deductible investment debt on a monthly basis while remaining in strict adherence to Canada Revenue guidelines. With the appropriate mortgage structure, you can generate free tax refunds simply by making your mortgage payments.
The average annual refund ranges between $2000 – $5000 per year. This number depends on:
- property value
- the size of the mortgage
- the owner’s marginal tax bracket
- interest rates
- length of time spent in the mortgage plan
Your refunds can be applied as principle pre-payments to the outstanding balance of your mortgage, reducing amortization and saving on interest. Additionally, by reinvesting tax refunds and interest savings, additional wealth can be built for retirement without affecting monthly cash flow. No additional cash is required out of pocket and mortgage payments can be made the same as before. The plan is, in essence, self-funding.
By The Numbers
Let’s say you have a mortgage of $200,000 at 7% interest over 25 years. This would amount to approximately $220,000, which is more than the original loan itself. Additionally, Canadians pay their mortgage with “after-tax” dollars and, at an estimated this at a 40% tax rate, this would tack on an additional $280,000.
Here’s the breakdown:
$200,000 (mortgage) + $220,000 (at 7% interest) + $280,000 (tax) = $700,000 (to pay back a $200,000 mortgage)
The numbers are staggering. So the question now becomes “how does one reclaim any tax dollars and use them to one’s advantage?”
A quick case study
Jim and Lisa buy a home for $500,000. They are in 39% marginal tax bracket. Their mortgage is $250,000 and they will pay it off in 25 years at an average rate of 4.5%. They have $150,000 in equity which can be used to set up their cash flow asset. Jim and Lisa decide to implement a Tax Deductible Mortgage Plan.
Here are the benefits:
- Accumulated investments can be sold and used to pay off all loans
- They earn $98,000 in tax refunds which can be used to make extra mortgage payments
- They achieve mortgage freedom in 14.5 years (instead of 25 years), achieving $172,000 in future savings
- Additional tax refunds and savings accrued after mortgage freedom is achieved can be used for future investments
For whom will this work?
This sort of plan is optimal for those who have between 30% – 50% equity (the minimum would be 20%) in their property with good credit and are employed or self-employed. For those already on track to pay off their mortgage within 3 – 5 years, this method likely is not the most optimal but there are several other strategies one can use to generate similar financial benefits from their mortgage.
Would you like to know more about a Tax Deductible Mortgage Plan?
