# GIC or pay down mortgage???



## superk (Dec 4, 2011)

I currently have about $30,000 to invest. I am looking for a safe investment, as I'll need that money for a down payment in about two to three years. I am considering two options:

a) Invest in GIC (approx. 1.6% to 2% for 2 to 3 year term)

b) Pay down the mortgage on a cash-flow positive rental property. OSB: $95k. Remaining mortgage term: 3 years. Interest: 3%. When the term is up, I will be refinancing so I can take out as much equity as possible (to use towards the new downpayment) while ensuring the rental property remains cash flow positive under the new financing terms. (My mortgage product is BMO's Homeowner's Readiline, so if I have a cash emergency in the next two to three years, I can borrow cash under the revolving portion. I also have other emergency cash, so the likelihood of having to borrow cash is slim to none). 

The only downside I can see of paying down the mortgage is that I will have less interest expense to deduct; I am reporting rental income as part of my personal income. But with the low OSB, I'm not sure if this makes that much of a difference. ($95k x 3% = $2850 interest cost vs. $65k x 3% = $1950 interest cost. Difference = $900). My marginal tax rate is probably 35 to 40%.

I do not have the stomach for more aggressive investments.

Option B seems to be the better option, but am I missing something here???

Your thoughts/advice/opinions/analysis would be appreciated! Thanks!


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## andrewf (Mar 1, 2010)

I would use a 2% savings account at Ally before accepting less than that for GIC.

I agree that repaying the mortgage is more sensible and has a higher ROR. Hopefully the $30k is in addition to your emergency fund.


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## jamesbe (May 8, 2010)

Why pay the mortgage on a rental? Doesn't it make more sense to write off the interest as a loss?


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## NorthernRaven (Aug 4, 2010)

You can get 2.5-3% on 2-3 year GICs from the Manitoba credit unions. A couple of them provide early cashability (with 1% or 1.75% interest) in case you needed the money unexpectedly. If you need CDIC guarantees rather than Manitoba, I think Peoples Trust makes Manitoba-ish GIC rates (non-cashable) available to its own customers, although they don't post them for the general public/brokers.

Ally (and a few others) would be the top of the CDIC GICs otherwise - around 2-2.25% on 2-3 years. Ally's 2-year GIC is interesting in that it will let you raise your rate one in that time if rates go up, and you can cash out Ally GICs early at 1%.

Might be something to look into if it would tilt your decision.


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## K-133 (Apr 30, 2010)

jamesbe said:


> Why pay the mortgage on a rental? Doesn't it make more sense to write off the interest as a loss?


You'd have to pay taxes on the investment growth (GIC or other) which would essentially neutralize the write off taxes saved.

My vote would be to pay down the mortgage. 

I too am an advocate for revenue neutral rental properties (depending on one's horizon) but this make the most sense to me.


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## andrewf (Mar 1, 2010)

Here's a thought experiment. Going with GICs is identical to repaying the mortgage, readvancing on the mortgage at 3% and buying GICs at 2%. That is cashflow negative before and after tax.


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## iherald (Apr 18, 2009)

You didn't say what your next mortgage would be on. Remember, the test for the ability to write off interest on a loan isn't what property the loan is on, but what the purpose of the loan is for.

So if you're going to remortgage your investment property to buy a personal property you're SOL. There are ways around it, but you have to be careful of that issue.

Otherwise, to your original question, I'd max out your TFSA, and put the rest towards your mortgage.


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## superk (Dec 4, 2011)

Next mortgage will be principal residence. 

When the mortgage term on the rental is up, I would like to renegotiate a new mortgage and cash out as much as possible. Assuming similar property value and interest rates as today (let's assume!), I should be able to pull out at least $50k equity and have the rental still cash flow. If I pay down another $30k now, I could also reclaim that amount (therefore $50k + 
$30 k = $80k available for down payment). I can also pull out whatever principal I'm paying down as part of my monthly payments. In total, I think I might be able to cash out $100k. 

The intention of paying down an additional $30k now would be to decrease my interest costs (with the understanding I will have $900 less in rental expenses to claim annually), and increase the portion of my monthly payments going towards the outstanding principal. 

TFSA is already maxed.


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## K-133 (Apr 30, 2010)

superk said:


> Next mortgage will be principal residence.
> 
> When the mortgage term on the rental is up, I would like to renegotiate a new mortgage and cash out as much as possible.
> 
> TFSA is already maxed.


You should speak to a professional on this. I read an article recently, I believe on MoneySense where a person owned two homes, living in one renting out the other. The one which was lived in had no mortgage on it. They had to move to the city which the rental was in and therefore decided to move into that house. They basically swapped the mortgages and the CRA came back to them and denied them the interest expense on the new rental, because that money was actually used to fund their primary residence. The home owner took the CRA to tax court and lost.

This is an example of what iherald is saying. And why I suggest you speak to an accountant.

andrewf has a good point as well. I think you need to assess your long term goals to figure out the best option in GIC vs mortgage paydown.


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## iherald (Apr 18, 2009)

superk said:


> Next mortgage will be principal residence.
> 
> When the mortgage term on the rental is up, I would like to renegotiate a new mortgage and cash out as much as possible. Assuming similar property value and interest rates as today (let's assume!), I should be able to pull out at least $50k equity and have the rental still cash flow. If I pay down another $30k now, I could also reclaim that amount (therefore $50k +
> $30 k = $80k available for down payment). I can also pull out whatever principal I'm paying down as part of my monthly payments. In total, I think I might be able to cash out $100k.
> ...


Yeah, your loan will not be deductible. The purpose of the loan is to buy a personal property, not an investment one. 

I believe there are threads on here about how to get around it, but what you may do is sell the investment property to your Mom for full value, take the 'profits' to buy your house, and then mortgage your personal property to buy back the investment property. I'm not sure if that will work, but you may need to do something like that.


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## andrewf (Mar 1, 2010)

^ You'd have to weigh the tax advantages of that against realizing the capital gain.

If you plan to buy a personal residence soon, it tips the balance back to GICs. How soon is soon, though? What kind of gain are you looking at on your property?


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## cardhu (May 26, 2009)

superk said:


> The only downside I can see of paying down the mortgage is that I will have less interest expense to deduct;


Less interest expense to deduct, but *less interest expense*. All other things being equal, it is better to not pay the interest in the first place, than to pay it and get a partial “rebate” through tax relief. However, since you’re planning to reborrow against the rental property to buy a personal use property, all other things are not equal ... the reborrowing will not be tax-deductible, so that adds a bit of a wrinkle to the equation. 



superk said:


> When the mortgage term on the rental is up, I would like to renegotiate a new mortgage and cash out as much as possible.


Be careful ... you don’t want to end up with commingled debt, part of which is deductible and part of which is not. Some people say commingling should be avoided because of the additional bookkeeping headache it produces. Well, its true that there is some additional bookkeeping required, but it really isn’t at all difficult. No, the real reason that commingling is frowned upon is that it locks you into a sub-optimal and tax-inefficient cash flow pattern ... normally its best to focus your debt reduction efforts toward non-deductible debt first, while letting deductible debt ride. With a commingled debt, you can’t do this. 

Since you already have a BMO ReadiLine, you should be able to segregate the different categories of debt into separate accounts ... perhaps renegotiate to boost the overall credit limit under the package, but be sure to avoid commingling the debts, even temporarily (once commingled, always commingled). 

If you were planning to buy your new principal residence in the next 6 months or so, I would lean toward not paying down the existing mortgage ... however, since you are still 2 or 3 years away from doing anything, its not an easy determination ... the fulcrum in this scenario is the moment your new home purchase closes ... if you pay down the mortgage, your costs will be lower leading up to that moment, and you’ll arrive at that moment with a bigger down payment, but your costs thereafter will be higher because your proportion of deductible to non-deductible debt will be lower ... vice versa if you don’t pay down the mortgage ... somewhere in the middle of all that there is a crossover, where the outcomes would be equal either way ... pinpointing that crossover is the challenge. 

Incidentally, if you decide to go ahead and pay down the mortgage now and reborrow later, and if you have a substantial cash emergency fund lying around, then you might consider directing some of that against the mortgage also ... with the ReadyLine product, you already have secure access to low-interest financing in the event of emergency, so having a pile of cash on the side a little redundant and inefficient. 



jamesbe said:


> Why pay the mortgage on a rental? Doesn't it make more sense to write off the interest as a loss?


Intentionally losing money, in order to produce a deduction, is generally a poor wealth-building strategy. The loss will always outweigh the tax break.


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## Lephturn (Aug 31, 2009)

iherald said:


> Yeah, your loan will not be deductible. The purpose of the loan is to buy a personal property, not an investment one.
> 
> I believe there are threads on here about how to get around it, but what you may do is sell the investment property to your Mom for full value, take the 'profits' to buy your house, and then mortgage your personal property to buy back the investment property. I'm not sure if that will work, but you may need to do something like that.


Bzzzt. That sounds like a non arms-length type of transaction that would get you in trouble with the CRA. This is a transaction that you are doing with a close relative for the sole purpose of avoiding taxes, and I'd bet they would still not allow you to claim the mortgage interest as an investment loan. Well you would claim it, but they would disallow that and you'd owe them the taxes back along with interest.

Speak to not just any accountant - but one experienced with persons that own rental properties.


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## andrewf (Mar 1, 2010)

My understanding is that it is a legit transaction, so long as the sale price is for FMV.

1. A sells investment property (henceforth 'house') to B and receives promissory note from B.
2. A takes a mortgage to buy the house from B, paying cash.
3. B repays promissory note with cash
4. A uses cash to purchase primary residence

Thus, the investment property has a mortgage that was used to purchase it and is therefore deductible. The transaction occurred at FMV and any capital gains owing would need to be paid. Alternately you can just use cash flow damming, which might even make more sense as it avoids land transfer tax x2, legal fees, and delays the realization of the capital gain.


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## superk (Dec 4, 2011)

Thanks everyone for your comments so far. This is sounding a lot more complicated that I anticipated! I thought this was just a matter of crunching a few numbers to see if a $30k paydown on a 3% mortgage is better than a 1.6% return on a $30k GIC over a three year timeframe. 

I also thought at refinancing time:
- I could increase the amount borrowed from the "fixed" portion of the loan on the rental -- i.e. cash out $100k. (I did not plan on borrowing from the revolving portion of the loan and writing off any interest expenses) 
- I could use the $100k towards the downpayment of the principal residence. (I am aware I cannot deduct any interest expense on the principal residence)
- I can continue to deduct the interest expense on the rental property.

It sounds like I might be off the mark, so I will definitely speak to a professional. (If anyone knows a good accountant with experience in rental properties in the City of Vancouver, please let me know!)


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## Lephturn (Aug 31, 2009)

andrewf said:


> My understanding is that it is a legit transaction, so long as the sale price is for FMV.


I think CRA could disallow it for two reasons. #1 - non arms-length. It's your mom. #2 - tax evasion - any transactions done for the sole purpose of avoiding paying taxes they can disallow.

If you did it at FMV you might get away with it, but if they look at it closely they could easily disallow it as well.


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## andrewf (Mar 1, 2010)

So if it was your best friend instead, it would be fine? 

This is no more of a tax evasion scheme than the Singleton case. But, if you are concerned you can go with plain vanilla cash flow damming. That is unequivocally legit, if properly executed.


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## Elbyron (Apr 3, 2009)

andrewf said:


> So if it was your best friend instead, it would be fine?
> 
> This is no more of a tax evasion scheme than the Singleton case. But, if you are concerned you can go with plain vanilla cash flow damming. That is unequivocally legit, if properly executed.


Actually a better example than Singleton would be the Sherle case. She tried to take out a mortgage on her original property to use as downpayment on a new property, and then was claiming deductions for the interest on that mortgage, because she was renting out that property. She argued with the CRA and lost in court (direct use of borrowed funds was clearly personal). But the interesting part is that Sherle argued that she could have done the following: 

On day 1 she sells her residence, the Joyce Property, to her friend Ms. A. The purchase price is paid by issuing a Promissory Note;
On day 2 she takes a bank loan to discharge the mortgage on the Ewart Property (the first loan). While the loan might only be a daylight-bookkeeping entry, there is adequate security for it given that a collateral charge will be immediately available on the Ewart Property upon the payout of the former charge against it;
Also on day 2, she buys back the Joyce Property (her new rental property), and finances this acquisition by borrowing money from the bank, which loan is secured by a mortgage on the re-acquired property (the second loan);
The proceeds of the latter mortgage are paid to her friend Ms. A as consideration for this buy-back and Ms. A uses the proceeds to pay off the Promissory Note she issued on the purchase of the property the day before;
The proceeds from the Promissory Note are used by the Appellant to pay off the first bank loan;
The only remaining loan is the second loan taken to acquire a rental property;
Everything is done at fair market value without tax consequence, and actual transfers of land need never be registered.
The judge agreed that she could have done it this way and everything would have been legal. But since she didn't do this, she lost. 

So, I agree with Andrew: using a friend, or Mom, to sell & rebuy your property is perfectly legal as long as fair market value is used. Being able to execute the shuffle without actual transfer of land is helpful too, if your province has high land transfer fees. The CRA can look closely at it, and try to disallow it, but you could go to court and quote the Singleton and Sherle cases, and you would win, because the rules support this legitimate asset shuffling.


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