I hate debt.
I’ve never had a car loan, and I pay off my credit cards in full every month.[ad#Google Adsense 336×280-IA]The only debt I’ve ever had is mortgage debt.
When I bought my first house with a 5.25% interest rate, I put as much toward the down payment as I could.
After the financial crisis, the bank voluntarily lowered the rate to 4.75% for free.
And over the years, I made extra payments to pay down the principal.
I told you, I hate debt.
But our current low-rate environment has got me softening on my position a bit…
Record-Low Mortgage Rates Equal “Free” Money
Today’s low interest rates are killers to savers – but they’re a godsend to borrowers.
We just sold our house and bought a new one. This time, I got a ridiculously low 3.25% fixed rate.
Instead of taking the profits from the old house and plowing it into a down payment to lower my debt load, I did something different.
At 3.25%, I took on as much debt as the bank would allow.
The reason? Because it’s like getting free money from the bank to invest.
I can make more than 3.25%, even after taxes, on that money. And don’t forget: The interest that I’m paying on the loan is deductible.
Let me explain.
Putting the Bank’s Money to Work
Usually, the bank takes your money (in the form of deposits) and invests it in loans to make money for itself. I’m doing the opposite. I’m investing the bank’s money to generate income for me.
Let’s say I got $100,000 from the sale of our previous home. Rather than using that cash toward a larger down payment, I borrowed the same amount from the bank at 3.25%.
That means my monthly payment on that $100,000 is $435.21. At the end of 10 years, I’ll have paid $27,482 in interest.
The 27 grand comes off my taxable income. So, assuming a 33% tax bracket, I’ll save $9,160 in taxes for a net cost of $18,322.
Now back to the $100,000 I invested. Using my 10-11-12 System, which is featured in my book Get Rich With Dividends and in The Oxford Income Letter, I’ll come out way ahead.
The Oxford Income Letter’s Compound Income Portfolio is designed to generate average annual returns of 12% over 10 years. We accomplish this by investing in conservative companies that raise their dividends every year.
After 10 years of reinvesting the dividends, I’ll have $326,203.
Subtract the $18,322 I’ll have paid in interest and my $100,000 principal, and I wind up with $207,881.
Last but not least, give 15% to the IRS (the current tax rate on capital gains and dividends) and the net is $176,698. (Just keep in mind: Tax rates can change.)
If your time horizon is longer than 10 years, the numbers get even larger.
What if you need income today and don’t want to reinvest dividends? You can still come out on the plus side.
Pay Your Mortgage, Earn an Extra $40K
Let’s assume you get a) that same 3.25% loan whose mortgage interest reduces your taxable income, and b) a 4% yield that rises every year and is taxed at 15%.
In The Oxford Income Letter’s Instant Income Portfolio, the goal is to achieve an 11% yield within 10 years. I designed it for investors who need rising income now.
Starting with a 4% yield, an investor will have collected $69,856 in income over 10 years by investing $100,000 in the 10-11-12 System. Now subtract the $18,322 net interest (after tax savings), and pay Uncle Sam 15% of your dividends…
You still wind up with an extra $41,055 courtesy of Citibank, Chase or whichever financial institution gives you that low interest rate loan. And that doesn’t take into account the gains you’d make from the very strong likelihood that your stocks will have gone up over the 10 years.
The low interest rate is key here.
If your credit isn’t good or you don’t qualify for a loan below 4%, it’s harder to make the numbers work. And if you’re not deducting mortgage interest (not everyone does), the advantage of this strategy is reduced, so talk to your tax advisor.
Lastly, you also need to be certain that no matter what happens to the stocks you’re invested in, you can make that monthly mortgage payment. There’s no sense in collecting a dividend check if the bank is repossessing your house.
But for those with a long enough time horizon and the ability to get a mortgage below 4%, this is a rare opportunity to use the bank’s money to generate income for you.
Source: Investment U