...But You Have To Pay Tax

Just a short post today and a slight rant about tax...

I was recently reading another blog post about the pros and cons of real estate investment.  There were several comments below....and one really stuck out.

Here is the comment:

"There is no money in landlording. I bought one condo after prices went down by 50% paid cash for it.  Still only make 6% return on it and that if I have tenant renting all the time. Any maintenance or repair or unoccupied take profit off 6%. so if I include that then the return is more like 4%.  Plus you have to pay income tax on it. You tax go up every year. Your maintenance fee go up every year. And you can’t raise rent much or not at all."

I can appreciate his comments, but what really ticks me off is the comment about tax...."Plus you have to pay income tax on it".

....Really?

Tell me a way to make money without paying tax....other than winning the lottery.

It's funny because this is not the first time I have heard this comment.

"Oh yeah, he made $50K on that property, but he has to pay tax.".....no kidding

"That guy makes over $100K.  Think of the tax that he pays!"....yep, probably true.

In Canada, if you make money, you have to pay tax, or you go to jail. 

Being tax efficient is another story.  Deferring tax or starting a corporation to reduce tax is smart.  Avoiding tax all together is another story.

So please, if someone makes money, don't complain about the tax to be paid.   Someone has to pay for the road repairs in our great country!

HELOC vs PLOC

The basic principle of a line of credit is fairly straight forward…the bank thinks your credit rating is good enough to justify borrowing you more money than they already have.  

As I mentioned in my last post, I think it is a good idea to gain access (but not necessarily use) a line of credit as soon as you can.  The reason for this being that it is a good safety net to have in case of any unforeseen events.  Used PROPERLY, it can also be used for investment purposes, although I would not necessarily recommend this route….investing with borrowed cash can often turn ugly if you do not know what you are doing.

So you have decided to gain access to a line of credit?  Good stuff.  DON’T use it as your piggy bank and DO pay off the balance as quickly as possible.

Next question: Personal line of credit (PLOC) or Home equity line of credit (HELOC)?

Well if you don’t own a home, the answer is fairly obvious.  For those that do own a home, I would argue that the HELOC is the better option due to the flexibility of payment options and the lower overall interest rates, but I will go over the differences.

The PLOC is fairly easy to obtain.  At your local bank, you will fill out an application, giving them your basic info.  They run a credit check, calculate how much debt you are servicing otherwise (car payments, mortgage, credit card, etc) and come back with a “yes” or “no”.  If yes, they attached a dollar value to the approval and you are all set.  

The interest rate is also dependant on your credit history.  The better your credit, the better your interest rate, although this rate will never be lower than a HELOC.  The reason it is always higher is that it is “unsecured”, meaning you are not putting up anything as collateral in case you take the money run.   

The payment terms are slightly different at each bank, but at TD the ‘repayment term’ is 3 years, meaning that if you max out your credit, say $15,000, you need to repay $416.66 per month, plus interest.  This is automatically taken out of your account each month.

HELOC is slightly different.  The premise behind it is that the banks will lend you cash up to 80% of the value of your home, less any mortgages outstanding. 

If you have a $250,000 home and have a mortgage on the property of  $215,000….sorry, no HELOC for you.   The Loan to Value ratio is above 80%....(215/250 = 86%)

But if you had a mortgage of $170,000, you would be eligible to borrow $30,000, provided the credit check comes back relatively clean and your house has been accurately valued at $250,000

80% of $250,000 = $200,000 minus your mortgage of $170,000 = $30,000

Sign me up right!?

Well, here is where the downfalls come into play.

For one, there is an initial set-up cost.   To get the application process started, you have to put your estimated home value through a computer valuation system at a cost of $99.  The tough part is that you have to estimate the value of your home by yourself!

If you estimate incorrectly….your application is denied and you need to have a ‘human’ appraise your home at a cost of $300….so make sure your  valuation is correct the first time! J

Registering your HELOC on title comes with a cost of another $495, so worst case scenario, you are looking at $795.

Yikes you say!...well yes and no.

Let’s look at an interest comparison.  The interest rate on my PLOC was 5.25%.  The rate on my HELOC is 3.7%.  If I have a drastic emergency and need $25,000 fast, the interest for 1 year on that money at 5.25% is $1312.50.  At 3.7%, the interest is only $925….a savings of $387.50

And remember, you may have this HELOC for a long time, so you will make up the up-front cost through interest savings.

Payment terms are also an advantage for the HELOC.  The minimum payment is interest-only, meaning if you borrowed $25,000 at 3.7%, your cost is only $77 per month….but don’t forget you have to re-pay the principal eventually…and the sooner the better.

So what option is best for you?

Emergency Fund VS Line of Credit

Countless personal finance" gurus" try to drive home the fact that everyone needs an “emergency fund” to cover any unseen costs that might arise in the future.  The amount of money that they recommend to have stashed away, however, seems to be different.  It can vary greatly…. 1 month, 3 months, 6 months and even 9 months of earnings is not out of the question.

For many people, I do agree, that having a ‘rain-day’ fund is a good idea, but in my opinion, this is unnecessary if you can obtain a line of credit.

Let me explain….

A lot has been said in the media recently about the personal debt of Canadians and the “danger” we are in if interest rates move too quickly.  This may be true for certain people who adopt a “buy now, pay later” philosophy for all consumer goods and use a line of credit as their piggy bank….but my philosophy is that you should gain ‘access’ to all available credit BEFORE you need it because chances are you can’t predict the future….but if you can, please contact me asap.

There may be unexpected home repair (especially if you own a few investment properties on top of your existing home), you might have a large auto repair bill, medical bills, etc, etc.

Why not have an ‘emergency fund’ for these types of occurrences??

In my opinion, having an emergency fund just sitting in a bank account is not the best use of money.  Each day, this money will lose value due to inflation and I would much rather have that same amount of money invested in a liquid asset MAKING money.  In addition, having 3 months of earnings stashed away for example may not be enough to cover a large repair bill…and then where do you get the extra cash that you need?

For these reasons, my emergency fund is a line of credit.

Here is a quick comparison:

$5000 in a “high interest” (laugh) savings account at 1.5% will be worth $4925 in 1 year adjusted for 3% inflation.  $5000 invested in Skyline REIT (currently yielding 9% on their commercial properties) will be worth $5300 in 1 year adjusted for 3% inflation.  This is a swing of $375.

If you need money fast and you have access to a line of credit, you can use the line of credit for the short term fix and either pay off the balance according to the payment terms or use the $5300 from your investment account to pay off the balance….(assuming you didn’t need more than this during your ‘emergency’)

Adding to this flexibility is the fact that a home equity line of credit (HELOC) can offer even more flexible payment terms.

More on lines of credit in my next post!