# Paying Mortgage With Dividends



## tygrus (Mar 13, 2012)

I am looking for advice on whether this is financially prudent.

Instead of paying down my mortgage which is 3.5% interest rate, I invested a sizeable sum in REITs yielding double that and then turned the dividend into my mortgage payment.

My logic that was paying off debt just deadens the money while this way, the mortgage is paid and both my house and investments can grow in value. The only issue is that I am paying mostly interest on the mortgage so I will end up paying probably double for the house in the long run.

My question is does that factor negate the growth potential in the equities? How do I figure this out?


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## MoneyGal (Apr 24, 2009)

Not that hard to model. 

Figure out what your mortgage is going to cost you based on your current and expected payment plan. There are free Canadian mortgage calculators at dinkytown.net. Also estimate the final value of your house when the mortgage is paid down - you will need to figure out an expected ROR for your house. 

Then figure out what your expected ROR is over the same time period using your current invested amount, an estimate for dividend yield, and not reinvesting the dividends. 

If you want to make this more realistic/complex you will factor in tax on the housing gain (there isn't any) and tax on the dividends used to pay the mortgage. 

So, scenario 1: I pay down mortgage with lump sum (eliminate mortgage?) - where am I after period x (calculated as increase in net worth, I expect(? 

Scenario 2 (what you actually did): take the lump sum and invest in dividends instead, paying down the mortgage over period x - where are you now?


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## lonewolf (Jun 12, 2012)

The only way I would do this is with private reits


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## Eclectic12 (Oct 20, 2010)

First off, I'd recommend an apples to apples comparison. 

Typically paying down the mortgage is done with after tax dollars. The investments are all going to make payments with pre-tax dollars. Without taking the investment taxes into account, there may not be anywhere near as much being paid off of the mortgage as you think.


Secondly, REITs typically pay a small amount (if any) of their cash payments as an eligible dividend. They pay a mix of income. This is important to your evaluation as you have to pay the taxes on the different types. 

If RioCan is one of the REITs, the 2013 cash payments had something like 69% being taxed the same as interest/employment income. On paper, $1.41 is available to pay down the mortgage but something like $0.97 is going to be taxed at a high rate. At a high tax rate of 40%, about $0.39 of the $0.97 is going to be needed to pay the taxes (or if the full $1.41 was put against the mortgage, other cash will need to be found).


If on the other hand, most of the cash distribution is return of capital (RoC), then the best case is that the capital gains tax is deferred until the investment is sold or if part/all had to be reported on one's annual tax return, at least it's at a better tax rate.


Bottom line is that without knowing how much additional tax is being racked up and what type it is, how far ahead or behind you will be compared to paying down the mortgage is difficult to assess.


Cheers

*PS*

If the investments are held in a TFSA, then the tax aspect goes away and the full cash payment is available to pay down the mortgage. Then it will be an apples to apples comparison, based on the payments.


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## tygrus (Mar 13, 2012)

The tax benefits are considerable in this scenario. You are actually using tax free income in the form of dividends (via the dividend tax credit) to create a capital gains exemption on your primary residence. The leverage is actually formidable and not all that risky. 

At the end of this, you would have two massive assets paid for and still throwing dividend cash flow off to you in retirement.

And I just used REITs in my scenario, but this could be some ETF as well. There are some paying almost 6%.


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## HaroldCrump (Jun 10, 2009)

lonewolf said:


> The only way I would do this is with *private reits*


You must be joking.



tygrus said:


> The tax benefits are considerable in this scenario. You are actually using tax free income in the form of dividends (via the dividend tax credit)


How are dividends tax free?
The DTC is a tax credit, it is not the same thing as being tax free.
You are aware, right, that the dividend gross up can have detrimental impact on your tax situation?

If you are counting on ROC, that is not free either.
Once your ACB becomes 0, further ROCs will generate capital gains taxes.

Anyhow, my point is that there is no free lunch.
High yield stocks are not risk free.
It is not like govt. bonds are paying you 6%.

You are leveraging a guaranteed liability (your mortgage) with risky investments (high yield stocks/REITs).
IMO, you are burning the candle at both ends.

If you want to offset some of your mortgage liability, you have two options:
- Invest in GICs or govt. bonds held to maturity (in this case I'd question why not apply same amount to pay off the principal instead)
- Invest for dividends inside TFSA, and withdraw dividends to pay mortgage (in this case as well there is no free lunch - you are trading off growth of your TFSA for paying interest on mortgage)


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## tygrus (Mar 13, 2012)

HaroldCrump said:


> .
> IMO, you are burning the candle at both ends.


I understand, then in that case, its better just to pay off the mortgage and be done with it, piece of mind and all that is worth something as well.


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## MoneyGal (Apr 24, 2009)

What Harold said. Dividend income is tax-preferred, not tax-free, and will gross up your income for the purposes of calculating social benefits paid through the tax system (not applicable unless you are eligible for the GST credit, the OAS, or CCTB. You can also lower the income upon which benefits are calculated by making RRSP contributions). 

Might be worth a trip to an accountant to model your exact situation.


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## tygrus (Mar 13, 2012)

MoneyGal said:


> Might be worth a trip to an accountant to model your exact situation.


My account would probably just say pay off your largest highest interest rate debt that is not tax deductible. In that case, its my mortgage. My business debt is a point higher but all the interest is fully deductible.


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## MoneyGal (Apr 24, 2009)

Then get another accountant! After-tax return is everything.


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## Eclectic12 (Oct 20, 2010)

tygrus said:


> The tax benefits are considerable in this scenario. You are actually using tax free income in the form of dividends (via the dividend tax credit) to create a capital gains exemption on your primary residence.


You said REITs so the amount of cash being paid that likely qualifies for the DTC is probably small.
In my example of RioCan there is 0% in 2013 that qualifies for the DTC, where it looks like only one year in the last fifteen has any amount that qualified.

For RioCan, there's only something like a 30.5% tax advantage over interest and possibly a tax disadvantage compared to a company paying 100% eligible dividends. In both cases, taxes are going to be charged.

Then too ... the DTC is to compensate for the corporation paying taxes in addition to the investor so it is tax advantaged but is not tax free.





tygrus said:


> ... The leverage is actually formidable and not all that risky.


What leverage?

You have taken existing cash to buy an investment. 
As I understand it, leverage would be more like what I did - borrow using the HELOC to buy the investments and then use the cash stream to pay down the mortgage as well as write off the interest charges against other income.




tygrus said:


> ... At the end of this, you would have two massive assets paid for and still throwing dividend cash flow off to you in retirement.


Assuming the investments don't tank ... though as I say, as long as one buys REITs, there will be almost no dividends but mostly other types of income paid as cash.


As also mentioned above, the only way to avoid the added taxes of the investment income is a TFSA.

Cheers


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## Eclectic12 (Oct 20, 2010)

tygrus said:


> I understand, then in that case, its better just to pay off the mortgage and be done with it, piece of mind and all that is worth something as well.


If you want piece of mind ... then yes.

Without knowing what the investments are as well as what the taxes will be - the main thing that is clear is paying down the mortgage is simple, has little to no risk and is likely to be easy to sleep at night.


Cheers


*PS*

If you have a TFSA with investments that pay cash - a low risk way to accelerate the mortgage being paid is to withdraw the cash as often as the TFSA allows and pay down the mortgage. It's tax free so the full $1 withdrawn from the TFSA can be used to pay down the mortgage with no tax consequences.


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## My Own Advisor (Sep 24, 2012)

Why not do both? Kill the mortgage via lump sum payments and invest in dividend paying stocks? Then you don't need to choose one over the other. Even killing your mortgage if it costs you 3% interest after-tax, is more like a 4.5% guaranteed return on investment. 4.5% yield is what you'll have in a CDN bank stock, excluding any capital appreciation.


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## james4beach (Nov 15, 2012)

If this was such a great idea, then why is the bank even lending money to you?

Why would they lend to you at 3.5% when they could get (higher return) in REITs?


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## Pluto (Sep 12, 2013)

What you should do, if you are willing to have a mortgage and investments is,

1. pay off the mortgage and,
2. get a new mortgage to invest for income (eg dividends, bonds,). In this case the interest on your mortgage is tax deductible. 

(The caveat is, if your investments tank, you still have the debt to pay. Better to borrow to invest for income when we are deep in a bear market and dividend yields are higher than average.)


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## Eclectic12 (Oct 20, 2010)

james4beach said:


> If this was such a great idea, then why is the bank even lending money to you?
> Why would they lend to you at 3.5% when they could get (higher return) in REITs?


I'm not clear on what loan you are thinking of.

The OP said:


> Instead of paying down my mortgage which is 3.5% interest rate, I invested a sizeable sum in REITs ...


I interpret this to mean the OP is using his own money ... plus there's no mention of writing off the interest charges for an investment loan.

This seems to be a redirection of existing cash flow.

Cheers


*PS*

As for what the bank and it's subsidiaries will or won't do ... I suspect that what they know plus what's already on their books will play into this. For example, they agreed to my HELOC when I setup the mortgage but have had no say in the fact it is 100% investments.

On the flip side of the coin, they seemed to be worried about how much mortgage business they have on the books as they have left existing customers as-is but have stopped accepting new mortgage applications coming up on a year ago.


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## james4beach (Nov 15, 2012)

tygrus said:


> I am looking for advice on whether this is financially prudent.
> 
> Instead of paying down my mortgage which is 3.5% interest rate, I invested a sizeable sum in REITs yielding double that and then turned the dividend into my mortgage payment.


It seems to me all you've done is amplified your exposure to real estate. Since REITs themselves involve plenty of leverage, you've just found a way to enhance your leveraged real estate exposure.

As if the house wasn't enough exposure on its own, you've now piled money into REITs. Now if Canadian housing crashes, both your home value and your REITs will crash together.

As with any instance leverage is used, this just amplifies your gamble. It's either a great idea (if real estate stays strong) or a terrible idea (if real estate weakens)


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## lonewolf (Jun 12, 2012)

james4beach said:


> It seems to me all you've done is amplified your exposure to real estate. Since REITs themselves involve plenty of leverage, you've just found a way to enhance your leveraged real estate exposure.
> 
> As if the house wasn't enough exposure on its own, you've now piled money into REITs. Now if Canadian housing crashes, both your home value and your REITs will crash together.
> 
> As with any instance leverage is used, this just amplifies your gamble. It's either a great idea (if real estate stays strong) or a terrible idea (if real estate weakens)


 The banks promotes a lot of this kind of risk taking i.e., do not pay off mortgage invest in RRSP for tax break The banks then collect more interest on the loan & make more in fees with the money invested.

If this is done with a reit that is traded on an exchange" IS" the real risk/reward based on how well real estate does or is the risk/reward independent of real estate & based on the rules that govern" price" of that which is sold @ auction. I do not think this is a pure play on real estate but a play on price of that which is sold @ auction.


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## CPA Candidate (Dec 15, 2013)

I think the way to go about this is to compare risk adjusted returns on each option. Expected return = risk free rate + (expect return of market - risk free rate)*beta

Paying off the mortgage offers a risk-free after tax return of whatever your current mortgage rate is. It my case it would be about 2.9%. It's a low return.

Historical stock market risk premium (the expected return - RFR) is about 5%. If you consider simply investing in the index with a beta of 1, I would need a 0.029 + 0.05*1 = 0.079 or 7.9% return (after-tax) on a stock market investment to make up for the risk and for it to be a better option than paying down the mortgage. I have TFSA room so the tax component is not a issue in my case.

In my case I think I can earn at least this much in the markets, so I don't put any extra money towards my mortgage. Last year my portfolio returned 17%.


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## MrMatt (Dec 21, 2011)

james4beach said:


> If this was such a great idea, then why is the bank even lending money to you?
> 
> Why would they lend to you at 3.5% when they could get (higher return) in REITs?


It's a question of risk.
What if the REIT cuts their payout? Or you have to renew at a higher rate?

Throw in the tax impact and you've got a pretty high hurdle to clear before this strategy makes sense.


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## nobleea (Oct 11, 2013)

Seems you have spare cash lying around. The decision you have to make is whether you'd rather invest it or pay down the mortgage.
If you decide to invest it, it's just semantics as to where the dividends or payouts go. Whether you put the $1000 of dividends against the mortgage or against the monthly credit card bill, it's the same 1's and 0's.


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## james4beach (Nov 15, 2012)

CPA Candidate said:


> I think the way to go about this is to compare risk adjusted returns on each option. Expected return = risk free rate + (expect return of market - risk free rate)*beta
> 
> Paying off the mortgage offers a risk-free after tax return of whatever your current mortgage rate is. It my case it would be about 2.9%. It's a low return.
> 
> ...


I respect that analysis but personally I don't think 7.9% return is feasible long term. In the short term, anything can happen -- stocks are a total gamble. If you're only looking a few years out then you're just gambling in the stock market.

Average return figures apply to very long periods only. In the longer term, I really don't think you can get anything like 7.9%. Buffett doesn't think so either, by the way.

The only people who still think portfolios can return 8% long term are pension fund managers and people who read pre-2000 investment literature.


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## juniperpansy (Jan 5, 2013)

Have you looked into the Smith Manoeuvre? Basically it allows you to use investments to make your mortgage tax deductible. 
http://canadianfinanceblog.com/the-basics-of-the-smith-manoeuvre/


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## Eclectic12 (Oct 20, 2010)

nobleea said:


> Seems you have spare cash lying around. The decision you have to make is whether you'd rather invest it or pay down the mortgage.


From the wording used in the OP ... the decision has been to invest and it is only new funds that a decision is needed.




nobleea said:


> ... If you decide to invest it, it's just semantics as to where the dividends or payouts go. Whether you put the $1000 of dividends against the mortgage or against the monthly credit card bill, it's the same 1's and 0's.


If the investments in a taxable account - then using the full cash distributions either way may require finding other cash to pay the taxes (depending on the types/amount of taxable income paid).

A TFSA on the other hand, allows the full cash distributions to be used.


Cheers


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## KaeJS (Sep 28, 2010)

tygrus,

Paying a mortgage with dividends is an option. However, as my dear friend MoneyGal (and others) have suggested, you must take everything into account + the added risk.

You must also take into consideration the length of time you hold the mortgage. You are at 3.5% now. If you just pay your payments with dividends, what happens when your term is up? What if your REITs continue to pay _x_, but your mortgage rate when you renew is now _x + 0.5%_. What if the REITs go down in value _AND_ the mortgage term interest rate goes up (which is a very possible scenario)?

There are at least 10 variables to consider.

Unless you feel strongly about how you are going to execute this and you've got a solid plan in place after running the numbers over and over with different scenario plays... It's probably best to just pay off the mortgage and then start investing your newly saved cash.

Not to be rude (I apologize beforehand) but if you've made this thread asking if it's a good idea, then it shows you probably don't feel too good about the situation or your plan. If you don't feel strongly about your plan, it's usually best to choose a different option or work harder to make the plan concrete.

I'm not saying it is a bad idea by any means. I am saying you should run the numbers until it makes a good fit. :encouragement:

Personally - I have chosen to do both. I invest in Dividend Paying Companies (Canada only) and I also pay down my mortgage. Lately, it would have been better to invest more into the stocks, but that's the way the markets work. I rather reduce my risk and have piece of mind than try to squeeze out an extra couple hundred basis points.

Whatever you decide, I hope it works out well for you. Peace of mind has value.

$0.02


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## OhGreatGuru (May 24, 2009)

This thread needn't have gone beyond the replies by MoneyGal and Eclectic.

It's not hard to work out a proper comparison, provided you compare apples to apples;
The 6% ROI that OP has observed on his REIT is not all in CND Dividends, which throws his assumptions out the window;
Relative risk has to be taken into consideration.

There are numerous threads on the theme of "Should I invest or pay down the mortgage?" Nothing new here. (The preponderance of opinion (and evidence) is to pay down the mortgage.)


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## MoneyGal (Apr 24, 2009)

Nobleea's response was the most succinct. I provided some basic detail that was intended to get the OP to specify his assumptions, is all.


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