in less than 20 minutes I'm going to show you how to use the cash flow from your rental property to pay off your principal residence faster while making the mortgage on your house more tax efficient all with no added money let's go this is the Saskatchewan real estate [Music] podcast hey guys my name is Ron Corone I'm a mortgage broker based in Saskatchewan today I wanted to show you a strategy that is more relevant than ever given higher interest rates and the rising cost of home ownership that seems to continually outpace our earning capacity which is a problem that is affecting Canadians more today than at any time in history what I want to show you is how to structure your mortgage in a way that helps you be more tax efficient so that you can grow your real estate portfolio and keep more of your hard-earned money along the way then I want to show you how to use these savings your tax refunds to reduce your mortgage balance pay less interest and become mortgage free years ahead of schedule by paying off your your mortgage sooner you're going to free up expensive mortgage payments that hold you back which gives you more room for other more important things such as improving your lifestyle buying more real estate or getting a jump on retirement the amazing part about this strategy is it doesn't require additional cash you're simply reorganizing cash flows and payments that you already have in a way that's more tax efficient and the benefits come in the form of tax refunds and interest savings when you use those refunds to pay your mortgage off this helps to reduce your long-term interest costs faster and shorten amortization this can allow you to reinvest payment savings to build wealth and more assets so what is Cash damning Cash daming is the technical term attributed to the strategy by the Canada Revenue Agency it's the process of segregating non-deductible and deductible cash flows so that you can accurately and safely claim tax deductions on your mortgage debt so who is the strategy for if you're listening or watching this you're probably like most most Canadian homeowners you have a mortgage on your principal residence and you're paying for it with after tax dollars this brings us to a really tough reality when you look at the true cost of a mortgage it's significant most people already know that the cost of a mortgage is almost double because of the interest paid over time but very few people ever take into account how much earned income it takes to pay it off so the first roadblock that a lot of Canadians face is that we can't just pay cash for homes we don't have the resources we need to borrow the funds from the lender just to buy the home in the first place and because the government doesn't view our principal residence as an investment we can't write the interest off we're stuck using debt to finance our personal lives and we're servicing the interest with after tax doll basically the complete opposite of how wealthy Canadians manage their finances let me show you an example if we go back in time just a few years ago and buy a home for $750,000 today let's say it's worth a million let's say we put 20% down or $150,000 and borrowed the rest the 600 Grand the payments on the mortgage we make are with after tax dollars where we need to earn an additional 30 to 40% of income in order to pay the government first although we are eating up a major chunk of our disposable cash we have made our payments on time and we've even made some progress paying down our mortgage today we owe $500,000 and the home is worth $1 million so we have a net Equity of $500,000 unfortunately along the way interest rates moved up on us our payments increased life in general just got a little bit more expensive to the point where we had to make some concessions in order to maintain our lifestyle and stay in the home so we sacrificed the small amount that we were putting aside for Investments saying to ourselves once we get things under control we'll get those Investments going again now let's look at the wealthy person who could afford to pay cash for the house they put $750,000 down they just bought it outright but instead of leaving the funds in the property as debt Equity they borrowed back $600,000 and used the funds to purchase three more properties in the same price range $600,000 is enough to cover3 $150,000 down payments and closing costs initially the rentals just barely cash flow the rent essentially covered the operating costs at the property which meant they weren't making a ton of money but they weren't out of pocket either dollar for dooll the wealthy person and the homeowner are essentially both servicing the same debt load on the primary residence they both borrowed $600,000 with the exception that 100% of the interest on the wealthy person's mortgage is tax deductible because they borrowed the money to invest here's where it gets interesting for the entire life of that mortgage the wealthy person will pay 40% less interest that's over $244,000 in interest savings over 30 years at 5 0.45% which gives them options to buffer the impact of rising rates double down on their Investments buy additional assets and get even further ahead or just improve their lifestyle and because they use their Equity to build wealth rather than just leaving it sit there they now have four properties worth $1 million and $500,000 of equity each they have $2 million in total equity and we only have $500,000 plus each of the rentals generates income whiches have barely cash flowed at first but the value of these rents appreciated over time and the wealthy person is pocketing all that extra cash flow the most painful part of this entire exercise is the wealthy person is not only further ahead but they actually paid $244,000 less interest that we did on our home because they got all that money back in the form of tax refunds over the life of their mortgage now I know exactly what you're saying they started with more it's not fair they had enough money to buy the home out right the average Canadian doesn't have the luxury of paying cash for their home this argument is completely valid and it's not a fair comparison the point is simply to illustrate that there's a different way of approaching debt and that most of us are leaving money on the table because we haven't structured our finances correctly and that's not our fault we're not starting from the same place of understanding you can't do anything about your start point but you can course correct and change where you're heading just because because we don't have the same Financial advantages as the wealthy doesn't mean these tools and levers aren't available to us we simply must be more creative and manage our finances at a different scale that's where rental cash damning strategy comes into play because it allows us to structure our finances to take advantage of these benefits gradually over time with the right mortgage structure we can incrementally access your Equity to build wealth buy more real estate reduce the taxes you pay and improve your cash flow so that you can get more of your hard-earned tax dollars back reinvest the savings and take a run at inflation and the beauty of it is you can accomplish all of this simply by making your regular mortgage payment the ultimate goal here is converting your non-deductible debt as fast as you can and convert it into a tax deductible investment loan so that you can claim your maximum eligible tax refunds against the debt the reason this works is because the federal government has a rule that states if you borrow money to invest the interest on the borrowed funds are tax deductible because you borrowed with the intent of generating an income you can deduct the carrying costs of the loan keep in mind when buying real estate that it must be a rental it can't be for personal use this doesn't work for second homes or vacation properties that you don't rent out but it definitely works when you generate income from the property now that we have an understanding of how the strategy Works let's dive in further and look at some numbers to give you a sense of how powerful this can be and the kind of financial benefits a typical homeowner might expect over the life of their mortgage let's consider a typical scenario for a homeowner with a $500,000 mortgage and primary residence valued at $800,000 the first point to note is this only works when you have at least 20% equity in your home the reason for this is the multicomponent structures we need to run the strategy are only available to 8 % of the value of the home you do need to have a bit of equity to get started and if you're not there yet don't worry we got other strategies we can work on together in the meantime to get you to a point where you can start implementing more Advanced Financial techniques like this since the home is worth $800,000 the homeowner is technically able to set up a structure with a credit limit of $640,000 that's 80% of $800,000 they owe $500,000 on their mortgage which leaves another $140,000 that can be accessed and used as a down payment to purchase a rental property this gives them the ability to purchase a rental property worth approximately $500,000 they use $125,000 at the down payment plus they have a small buffer left around 15 grand for closing costs keep in mind you don't need to purchase a rental property if you already own one you can reorganize the cash flows from your existing portfolio and put the strategy to work right away without buying additional properties so just to recap for you we're requiring an income generating asset that will help us build additional wealth for the future we are going to structure our principal residents so that we can use the cash flows from the rental to convert our home mortgage into a tax deductible investment loan this is going to allow us to reduce our taxes and keep more of our hard-earned money in our hands and not the governments which help speed inflation and improve our lifestyle over time and we're going to accomplish all of this without any additional cash inputs beyond our regular mortgage payment let's now go over how to structure our mortgage and then we'll dive into some numbers for you for this strategy to work we need to set up a new multi-component mortgage on the principal residence with an investment line of credit attached to it there are lots of mortgage products out there that might look like they work for the strategy however in reality many of the products lack some of the features required to run the monthly cash flow cycle properly it's vitally important that the investment line of credit is set up for auto readvance which means that the principle that gets paid down on the non-deductible mortgage automatically becomes available to draw from the investment line of credit so that funds are available to be drawn out in a timely manner if the structure doesn't have that readvance feature it's going to cause friction and there will be implementation issues this may sound complicated but that's where I come in I work closely with you to make sure we have the right structure in place and I hold your hand help you get your cash flows going while you learn to implement the strategy now the ultimate goal here is to pay down your non-deductible debt as fast as humanly possible and the way we do that is by applying the rental income as a prepayment on the mortgage each month then we borrow that same amount from the investment line of credit to service the rental property expenses each month we convert more and more of your mortgage over to the investment line which results and increased tax refunds that you can use to pay down your mortgage even faster and accelerate your wealth building efforts so here's how it works we make our regular mortgage payment each month to the principal residents mortgage our payments are set to come from our household bank account same as before nothing changes then we have the rental property the little orange house at the top of the screen the monthly rental income is on the left that's where the money we get from the tenant and the rental expenses over on the right this could include things like principal and interest payments property taxes condo fees Etc the first thing that happens in the cash flow cycle each month is the tenant pays the rent on the first of the month we get a payment now what most Canadians will do is deposit the income in the bank likely an account dedicated for the rental and then pay the expenses on the property from the same account keep our rental cash flow separate from our personal cash flows but when we do it this way we miss a wonderful opportunity to create additional tax efficiencies for ourselves because there's actually no rule that says you need to use the rental income to pay our rental expenses when we receive the income from the tenant it's ours we can do whatever we want with it this takes a minute to get comfortable with because the natural tendency is to use the rental income to pay the rental expenses that just makes sense but there is a better way to manage the cash flow what we're going to do is use the rental income to pay off our non on deductible mortgage first because we don't get any tax benefits for carrying that mortgage it's a bad debt so let's get rid of it that's the first step we make our regular mortgage payment the same as before and we make an additional prepayment equal to the value of the monthly rent the principal portion of our regular mortgage payment plus the full value of the prepayment goes directly towards paying down our mortgage balance and the equity immediately becomes available in the investment line of credit which which we then draw back out to cover the rental expenses and run our landlord business that's it every single month we use the rental income to prepay our mortgage and we borrow the funds to cover the rental expenses that's cash damning it's really that straightforward in this scenario the homeowner has a $500,000 mortgage on their principal residence they use the mortgage to buy the home so they're not currently getting any tax benefits on the debt they're on a 30-year amortization at 5.45% which means their monthly mortgage payment is $284 their marginal tax bracket is 40% which means that for any debt they convert to a tax deductible investment loan they'll end up getting 40% of the interest back every year at tax time the rental property is worth $500,000 it has a mortgage on it with a balance of $375,000 so there's $125,000 in equity and the total annual cost to run the property is just over $33,000 annually or $2,753 per month to be precise the expenses include $25,000 for mortgage payments principal and interest $5,400 for maintenance condo fees and insurance and $2,400 for property taxes so in a moment we're going to explore a few different scenarios for each one the principal residence the rental property and the homeowner's Financial profile will remain exactly the same as it was displayed on the screen okay let's take a look at the cash flow cycle again but this time with the numbers from the case study we've got the principal residents in the center and we're making our regular mortgage payments of $2,884 monthly the payment comes from the homeowner's regular Household Bank account same as it does today no change up above we've got the rental property income on the left and expenses on the right we receive just over $33,000 in rental income annually on the property that's $2,753 each month and we can use that to prepay the mortgage and drive that non-deductible debt to the ground that Equity becomes available in the investment line of credit and we draw that same $2,753 back out into the rental checking account from there we use the funds to make all the payments on the rental property that's the cycle every single month we get our rental income and run it through the primary residence mortgage convert bad debt over to the the tax deductible side of the balance sheet and draw the funds out to pay our rental expenses here are the financials for the scenario where the homeowner already owns the rental property and does not need to borrow the down payment the first thing we look at is how long it takes to move the full balance of the mortgage over to the investment line we call this debt conversion and depending on how many properties there are it can typically take anywhere from 6 to 12 years to complete this first phase in this case debt conversion is achieved in year n this doesn't mean that the mortgage is paid off it just means that we've reached the point where the debt is completely tax deductible and we're receiving our Max annual tax refunds the next thing we look at is the total value of the refunds earned in the plan this assumes the rate of interest is constant and the marginal tax rate doesn't change either in reality these things can fluctuate but this gives us a sense of the total amount of tax refunds we can expect to achieve using this strategy in this case the homeowner receives $117,000 in refunds over the life of the mortgage technically the homeowner can do whatever they want with the refunds they can save the money or spend it but when we do projections like this we assume the homeowner will use the refunds to pay the mortgage down faster in this example the net effect of using tax refunds to accelerate the plan is they're able to pay off their mortgage 97 months ahead of schedule which saves them $272,000 in future mortgage payments taking into account that we make our mortgage payments with after tax earnings we can calculate the level of income required to make those payments at a 40% marginal tax rate we would need to earn $453,000 to make 97 payments that's close to half a million dollars of income savings that can go towards more important things and possibly help the homeowner retire many years ahead of schedule technically the homeowner is mortgage free 97 payments sooner than they otherwise would be and in order to provide an Apples to Apples comparison we assume they continue making payments and reinvest those 97 payments to the end of their original amortization so they can earn a rate of return on their future savings the calculator also allows us to play with different growth rate assumptions and for this scenario we're using 6% which results in a future value of the invest in payment Savings of $348,900 we also calculate the future value of the rental which is $1.2 million there are no outstanding liabilities the investment line of credit and the rental mortgage are both paid in full and finally we see the net wealth Improvement of $348,000 which is essentially the future value of the 97 payments at the 6% growth rate it's worth noting that our calculator allows us to include or exclude the rental property value depending on the circumstance ances in this scenario the homeowner already owned the rental property and would have benefited from the value appreciation with or without this strategy which is why we're excluding it from the rental value in the net wealth Improvement this is a taste of what rental cash daming can do for you and your family and I hope this has gotten you excited about how a strategy like this can absolutely change the way you look at mortgages and Investments if after watching or listening to this podcast you have more questions please feel free to use the calendar Link in the description of the podcast for more details thanks for checking out this episode of the Saskatchewan real estate podcast I hope you liked it found some value here don't forget to subscribe until next week I'm Ron coroni your Saskatchewan mortgage professional bye for now